Question

xyz company is considering investing in a project that costs rs 500000. the estimated salvage valuu is 0, tax rate is 35%. the company uses straight line method of depreciation and the proposed project with cash flows before depreciation & tax (CBDT) as follows
year           cbfd (rs)
1                100000
2                  100000
3                  150000
4                  150000
5                  250000
calculate the following : payback period and average rate of retur

Answer 1

Initial Investment = 500,000
Salvage Value = 0
Useful Life = 5 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = (500,000 - 0) / 5
Annual Depreciation = 100,000

Calculation of Payback Period:

Company can recover initial investment of 465,000 in first 4 years (100,000 + 100,000 + 132,500 + 132,500) and remaining 35,000 in fifth year

Payback Period = 4 + 35,000 / 197,500
Payback Period = 4.18 years

Calculation of Average Rate of Return:

Average Net Income = (0 + 0 + 32,500 + 32,500 + 97,500) / 5
Average Net Income = 32,500

Average Investment = (Initial Investment + Salvage Value) / 2
Average Investment = (500,000 + 0) / 2
Average Investment = 250,000

Average Rate of Return = Average Net Income / Average Investment
Average Rate of Return = 32,500 / 250,000
Average Rate of Return = 13%