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V & T Faces, Inc., would like to open a retail store in Miami. The initial...

V & T Faces, Inc., would like to open a retail store in Miami. The initial investment to purchase the building is $420,000, and an additional $50,000 in working capital is required. Since this store will be operating for many years, the working capital will not be returned in the near future.

V & T Faces expects to remodel the store at the end of 3 years at a cost of $100,000. Annual net cash receipts from daily operations (cash receipts minus cash payments) are expected to be as follows:

Year 1

$80,000

Year 2

$115,000

Year 3

$118,000

Year 4

$140,000

Year 5

$155,000

Year 6

$167,000

Year 7

$175,000

The company’s required rate of return is 13 percent. Assume management decided to limit the analysis to 7 years.

  1. What is the weakness of using the payback period method to evaluate long-term investments?
  2. Assume the manager of the company wanted to live in Miami and intentionally inflated the projected annual cash receipts so that the proposal would be accepted. The proposal would otherwise have been rejected. Explain how the company’s use of a post audit would help to prevent this type of unethical behavior.

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ekkarill92 answered 2 months ago
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