Payback Period and Accounting Rate of Return: Equal Annual Operating Cash Flows

Question

Payback Period and Accounting Rate of Return: Equal Annual Operating Cash Flows with Disinvestment
Roopali is considering an investment proposal with the following cash flows:

For parts b. and c., round answers to three decimal places, if applicable.

a. Determine the payback period.
Answer

years

b. Determine the accounting rate of return on initial investment
Answer

c. Determine the accounting rate of return on average investment
Answer

Initial investment-depreciable assets $125,000 Initial investment-working capital 19,000 Net cash inflows from operations (per year for 12 years) 18,000 Disinvestment-depreciable assets 14,000 Disinvestment-working capital 2,000

Explanation / Answer

(a). Payback period = 8 years

Explanation;

Formula of payback period is as follow;

Payback period = Initial investment / Cash inflow per year

Initial investment is given ($125000 + $19000) = $144000

Cash inflow per year is given = $18000

Now let’s put values in above given formula;

Payback period ($144000 / $18000) = 8 years

(b). Accounting rate of return on initial investment = 6.076%

Explanation;

Formula of Accounting rate of return on initial investment is as follow;

Accounting rate of return on initial investment = Annual accounting income / Initial investment

Initial investment is given ($125000 + $19000) = $144000

Cash inflow per year is given = $18000

Annual depreciation ($125000 – $14000) / 12 = $9250

Annual acounting income ($18000 – $9250) = $8750

Now let’s put values in above given formula;

Accounting rate of return on initial investment ($8750 * 100 / $144000) = 6.076%

(C). Accounting rate of return on average investment = 10.937%

Explanation;

Formula of Accounting rate of return on average investment is as follow;

Accounting rate of return on average investment = Annual accounting income / Average investment

Average investment will be ($125000 + $19000 + $14000 + $2000) / 2 = $80000

Cash inflow per year is given = $18000

Annual depreciation ($125000 – $14000) / 12 = $9250

Annual acounting income ($18000 – $9250) = $8750

Now let’s put values in above given formula;

Accounting rate of return on average investment ($8750 * 100 / $80000) = 10.937%

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