Problem 3
Solution:
Payback period is the length of time within which proposed initial investment is returned back to the company.
Payback period is calculated by taking two type of cash flows (1) Uniform Cash Flow each year and (2) Different Cash Flow each year
In the question given, cash flow falls in type (2). SO we need to find out the accumulated cash flow as follows:
Year |
Cash Flows |
Accumulated Cash Flow |
1 |
$42,500 |
$42,500 |
2 |
$57,500 |
$100,000 |
3 |
$86,400 |
$186,400 |
4 |
$86,400 |
$272,800 |
5 |
$86,400 |
$359,200 |
6 |
$86,400 |
$445,600 |
7 |
$86,400 |
$532,000 |
8 |
$86,400 |
$618,400 |
9 |
$86,400 |
$704,800 |
10 |
$86,400 |
$791,200 |
$791,200 |
Initial Investment = $337,000
From the above table, it is clear that the $337,000 will be recovered by the company between year 4 & 5. It means the payback period should be somewhere between Year 4 & 5.
Payback Period = Year 4 + ($337,000 – Already recovered amount till Year 4 i.e. $275,800) / Cash Flow of Year 5 i.e. $86,400
= 4 Years + 0.74 Years
= 4.74 Years or 4.7 Years
4)
Accounting Rate of Return = Average Annual Net Income / Initial Investment x 100
= $45,420 / $337,000x 100
= 13.5%
Year |
Cash Flows |
Less: Depreciation |
Net Income |
1 |
$42,500 |
$33,700 |
$8,800 |
2 |
$57,500 |
$33,700 |
$23,800 |
3 |
$86,400 |
$33,700 |
$52,700 |
4 |
$86,400 |
$33,700 |
$52,700 |
5 |
$86,400 |
$33,700 |
$52,700 |
6 |
$86,400 |
$33,700 |
$52,700 |
7 |
$86,400 |
$33,700 |
$52,700 |
8 |
$86,400 |
$33,700 |
$52,700 |
9 |
$86,400 |
$33,700 |
$52,700 |
10 |
$86,400 |
$33,700 |
$52,700 |
$454,200 |
|||
Average Annual Net Income ($454,200 / 10) |
$45,420 |
Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you
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