Artscape Inc. is considering the purchase of automated machinery that is expected to have a useful life of five years

Artscape Inc. is considering the purchase of automated machinery that is expected to have a useful life of five years and no residual value. The average rate of return on the average investment has been computed to be 20%, and the cash payback period was computed to be 5.5 years.

Do you see any reason to question the validity of the data presented? Explain.

Answer:
With an expected useful life of five years, the cash payback period cannot be greater than five years. This would indicate that the cost of the initial investment would not be recovered during the useful life of the asset. In addition, there would be no positive average rate of return because a net loss would result. If the 20% average rate of return and useful life are correct, the cash payback period must be less than five years. Alternatively, if both the 20% average rate of return and 5.5 years for the cash payback period are correct, the machinery must have a useful life much more than five years.