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:

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

2a. Compute the simple rate of return promised by the games.

2b. If the company requires a simple rate of return of at least 15%, will the games be purchased?

Explanation

2.

a.

The simple rate of return would be:

Simple rate of return	=	Annual incremental net operating income
		Initial investment

	=	$45,500	= 14.0%
		$325,000

b.

No, the games would not be purchased. The 14.0% return is less than 15%.

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