Louis Gallo 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. Gallo to offer frozen yogurt to customers. The machine would cost $7,950 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 $6,110 and $810, respectively.
Alternatively, Mr. Gallo could purchase for $9,800 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 $8,450 and $2,390, respectively.
Income before taxes earned by the ice cream parlor is taxed at an effective rate of 20 percent.
Required:
Determine the payback period and unadjusted rate of return (use average investment) for each alternative.
Alternative 1 Alternative 2
Payback period years years
Unadjusted rate of return % %