Ranking Investment Proposals: Payback Period, Accounting Rate of Return, and Net
ID: 2416805 • Letter: R
Question
Ranking Investment Proposals:
Payback Period, Accounting Rate of Return, and Net Present Value Presented is information pertaining to the cash flows of three mutually exclusive investment proposals:
Proposal.............................. X Y Z
Initial investment................. 98,000 98,000 98,000
Cash flow from operations
Year 1................................. 90,000 49,000 98,000
Year 2................................. 8,000 49,000
Year 3................................. 49,000 49,000
Disinvestment..................... 0 0 0
Life (years) 3 years 3 years 1 year
(a) Select the best investment proposal using the payback period, the accounting rate of return on initial investment, and the net present value criteria. Assume that the organization's cost of capital is 10 percent. Round accounting rate of return four decimal places. Round net present value to the nearest whole number. Use negative signs with your answers, when appropriate.
........................................................ Proposal X Proposal Y Proposal Z Best proposal
Payback period (years)................... __________ __________ __________ __________
Accounting rate of return Answer... __________ __________ __________ __________
Net present value........................... __________ __________ __________ __________
Explanation / Answer
Proposal X
Net Present value = PV of Cash Inflow - PV of Cash outflow
= 90000*PVF(10%, n year) + 8000*PVF(10%, n year)+ 49000*PVF(10%, nyear) - 98000
= 90000*.909+8000*.826+49000*.751 - 98000
= $27217
Payback Period
= 1+ (8000 /8000)
= 2 years
Accounting rate of return = Average Income / Average Investment
Average Income = (90000+8000+49000)/3 = 49000
ARR = 49000/ 98000
= 50%
Proposal Y
Net Present value = PV of Cash Inflow - PV of Cash outflow
= 49000*.909+49000*.826+49000*.751 - 98000
= $ 23814
Payback Period = Initial Investment / Cash inflow per period
= 98000/ 49000 = 2 years
Accounting rate of return = Average Income / Average Investment
Average Income = (49000+49000+49000)/3 = 49000
ARR = 49000/ 98000
= 50%
Proposal Z
Net Present value = PV of Cash Inflow - PV of Cash outflow
= 98000*.909 - 98000
= - 8918
Payback Period = Initial Investment / Cash inflow per period
= 98000/ 98000 = 1 year
Accounting rate of return = Average Income / Average Investment
= 98000/ 98000 = 100%
Proposal X should be accepted
Project X Year Cash Flow Cumulative Cash Flow 0 (98,000) (98,000) 1 90,000 (8,000) 2 8,000 - 3 49,000 49,000Related Questions
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