Basic Payback Period and Simple Rate of Return Computations [LO5, LO6]

Martin Company is considering the purchase of a new piece of equipment. Relevant information concerning the equipment follows:

Purchase cost . . . . . . . . . . . . . . . . . . . . . . . $180,000 Annual cost savings that will be provided by the equipment . . . . . . . . . . . . $37,500 Life of the equipment . . . . . . . . . . . . . . . . . . 12 years Required:

(Ignore income taxes.)

1. Compute the payback period for the equipment. If the company rejects all proposals with a payback period of more than four years, would the equipment be purchased?

2. Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life. Would the equipment be purchased if the company’s required rate of return is 14%?