In: Accounting
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:
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 |
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
(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%