OldSchool Corp

question 42

Essay

OldSchool Corp.is reviewing its method of evaluating capital expenditure proposals using the accounting rate of return method.A recent proposal involved a $200,000 investment in a machine that had an estimated useful life of five years and an estimated salvage value of $20,000.The cash flow from the new machine was expected to increase net income before depreciation expense by $56,000 per year.OldSchool's current policy for approving a new investment is that it have a rate of return of 12% and a payback period of three years or less.
(a)Calculate the accounting rate of return on this investment for the first year.Assume straight-line depreciation.Based on this analysis, would the investment be made? Explain.
(b)Calculate the payback period for this investment.Based on this analysis, would the investment be made? Explain.
(c)Comment on OldSchool's current policy for capital expenditure proposals.

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Definitions:

After-Tax Income

The amount of income that remains for an individual or a business after all federal, state, and withholding taxes have been deducted from taxable income.