Question

Exercise 12-1 Payback Method [LO12-1]

The management of Unter Corporation, an architectural design firm, is considering an investment with the following cash flows:

Year	Investment		Cash Inflow
1	$	56,000	$	2,000
2	$	6,000	$	4,000
3			$	8,000
4			$	9,000
5			$	12,000
6			$	10,000
7			$	8,000
8			$	6,000
9			$	5,000
10			$	5,000

Required:

1. Determine the payback period of the investment. ( )

2. Would the payback period be affected if the cash inflow in the last year were several times as large? ( )

Exercise 12-2 Net Present Value Analysis [LO12-2]

The management of Kunkel Company is considering the purchase of a $21,000 machine that would reduce operating costs by $5,000 per year. At the end of the machine’s five-year useful life, it will have zero salvage value. The company’s required rate of return is 12%.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.

Required:

1. Determine the net present value of the investment in the machine. ( )

2. What is the difference between the total, undiscounted cash inflows and cash outflows over the entire life of the machine?

Answer 1

Answer
							Answer - Exercise 12-1
Part 1)
Payback period is the period within which the investments (cash outflows) are recovered by the company with the use of annual cash inflows.
The calculations for payback period are shown with the use of following table:
Year	Investment $	Cash Inflow $	Investment Unrecovered (Difference between total cash outflows and inflows each year) $
1	56,000	2,000	54,000
2	6,000	4,000	56,000
3		8,000	48,000
4		9,000	39,000
5		12,000	27,000
6		10,000	17,000
7		8,000	9,000
8		6,000	3,000
9		5,000	0
10		5,000	0
Payback Period = Years Upto which Partial Recovery is Made + Balance/Cash Flow of the Year in which Full Recovery is Made
Using information from the table above, we get,
Payback Period = 8 +3,000/5,000 = 8.6 Years
Part 2)
No, a large cash inflow in the last year wouldn't make any difference because the total amount of investment has already been recovered between Year 8 and Year 9. So, any cash inflow occurring in the final year will have no impact on the value of payback period.
Answer - Exercise 12-2
1)                                                                                                                                                                                                                               $
Now	1	2	3	4	5
Purchase of machine	-21000
Reduced operating costs		5000	5000	5000	5000	5000
Total cash flows	-21000	5000	5000	5000	5000	5000
Discount factor (12%)	1	0.893	0.797	0.712	0.636	0.567
Present value	-21000	4465	3985	3560	3180	2835
Net present value	-2975
2)                                                                                                                                                                           $
	Cash Flow	years	Total Cash Flow
Annual cost savings	500	5	25000
Initial investment	-21000	1	-21000
Net cash flow			4000