Question

A company is trading in a fully depreciated old asset for a new one. Cost of the new asset is $5,000 with a 5 year life and straight-line depreciation will be used. The company receives a $500 allowance for the asset traded in. Additional sales revenue from the investment will be $2,100 and expenses of $400 (excluding depreciation). The company is in a 25% tax bracket. The payback period is:

a. 7.5 years

b. 8.33 years

c. 3.46 years

d. 2.95 years

34. Given the facts in question 53, the ARR is:

a. 17.8%

b. 23.3%

c. 8.9%

d. 8%

Answer 1

Ans: d 2.95 years

Pay Back Period (if cash inflows are even) =initial investment/Net cash inflows per year

Initial investment =5,000 – 5,00

                                   =$4,500

Pay Back period = 4,500/1,525

                              =2.95years

Working:

Statement showing calculation of Net Cash inflows per year

Particulars	Amount $
sales revenue	2,100
less: expenses	(4,00)
less: Depreciation	-1,000
$5000/5years
income before tax	7,00
less:Tax@25%	(1,75)
Net income	5,25
Add: Depreciation	1,000
Net cash inflows per year	$1,525

Note:

Depreciation is not a cash outflow so it is Added to Net income, it is Reduced only for Tax Benefit

34 Ans:

b 23.33%

Accounting rate of return = Net income/Average investment

=525/2,250*100

=23.33%

working:

Net income per year =$525

Average investment = (cost of the Asset + Residual value)/2

=$4,500/2

=$2,250