Calculating the Payback Period, Simple Rate of Return, and NPV

Nick's Novelties, Inc. is considering the purchase of electronic pinball machines to place in game arcades. The machines would cost a total of $300,000, have an eight-year useful life, and have a total salvage value of $20,000. The company estimated that annual revenues and expenses associated with the machines would be as follows:

Revenues

$200,000

Operating expenses:

Commissions to game arcades

$100,000

Insurance

7,000

Depreciation

35,000

Maintenance

18,000

160,000

Net operating income

$ 40,000

Required:

1. Assume that Nick's Novelties, Inc. will not purchase new equipment unless it provides a payback period of five years of less. Will the company purchase the pinball machines?

2. Compute the simple rate of return promised by the pinball machines. If the company requires a simple rate of return of at least 12%, will the pinball machines be purchased?

3. If Nick's Novelties, Inc. has a discount rate of 18%, what is the NPV of this investment? (Hint: Identify the relevant costs and then perform an NPV analysis.) Should the company purchase the pinball machines?