Seth Fitch owns a small retail ice cream parlor. He is considering expanding the business and has

Question:

Seth Fitch owns a small retail ice cream parlor. He is considering expanding the business and has identified two attractive alternatives. One involves purchasing a machine that would enable Mr. Fitch to offer frozen yogurt to customers. The machine would cost $16,200 and has an expected useful life of three years with no salvage value. Additional annual cash revenues and cash operating expenses associated with selling yogurt are expected to be $12,400 and $1,800, respectively. Alternatively, Mr. Fitch could purchase for $20,160 the equipment necessary to serve cappuccino. That equipment has an expected useful life of four years and no salvage value. Additional annual cash revenues and cash operating expenses associated with selling cappuccino are expected to be $17,000 and $4,860, respectively. Income before taxes earned by the ice cream parlor is taxed at an effective rate of 20 percent.

Required

Round your figures, including percentage rates, to two decimal points.

a. Determine the payback period and unadjusted rate of return (use average investment) for each alternative.

b. Indicate which investment alternative you would recommend. Explain your choice.

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...