Nick’s Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses.

Nick’s Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $325,000, have a fifteen-year useful life, and have a total salvage value of $32,500. The company estimates that annual revenues and expenses associated with the games would be as follows:

Revenues				$	220,000
Less operating expenses:
Commissions to amusement houses	$	60,000
Insurance		55,000
Depreciation		19,500
Maintenance		40,000			174,500
Net operating income				$	45,500

Garrison 16e Rechecks 2017-05-22

Required:

1a. Compute the pay back period associated with the new electronic games.

1b. Assume that Nick’s Novelties, Inc., will not purchase new games unless they provide a payback period of five years or less. Would the company purchase the new games?

Explanation

1.

a.

Computation of the annual cash inflow associated with the new electronic games:

Net operating income	$	45,500
Add: Noncash deduction for depreciation		19,500
Annual net cash inflow	$	65,000

Payback period	=	Investment required
		Annual net cash inflow
	=	$325,000	= 5 years
		$65,000 per year

b.

Yes, the games would be purchased. The payback period is equal to the maximum 5 years required by the company.

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