Question

Cafeteria is planning to install vending machines with a cost of $300,000.

 It is estimated that these vending machines will generate annual sales of 20,000 cups with a price
of $10 per cup.
 Cash variable costs are $4 per cup while cash fixed costs are expected to be $50,000 per year.
 The vending machine’s estimated economic life would be 5 years with a salvage value of $50,000
and depreciated using the straight-line method.
 BANE is subject to a 35% income tax rate.

REQUIREMENTS:
a. Determine the payback period;
b. Determine the accounting rate of return based on original investment;
c. Determine the accounting rate of return based on the average investment

Answer 1

Answer : Calculation of Payback Period :

Below is the table showing calculation of Cash Flows and cumulative Cash Flows :

Year	Cash Flows (Refer Table Below)	Cumulative Cash Flows
1	63000	63000
2	63000	126000
3	63000	189000
4	63000	252000
5	113000	365000

Payback Period = Complete Years + Remaining Cash flow / Cashflow for the year to be recovered

= 4 years + (300,000 - 252,000) / 113000

= 4.42 years.

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Investment	300000
Sales (20000 * 10)		200000	200000	200000	200000	200000
Less :Variable Cost (20000 * 4)		80000	80000	80000	80000	80000
Less :Fixed Cost		50000	50000	50000	50000	50000
Less : Depreciation [(300000-50000) /5]		50000	50000	50000	50000	50000
Earning before taxes		20000	20000	20000	20000	20000
Taxes @ 35%		7000	7000	7000	7000	7000
Net Income		13000	13000	13000	13000	13000
Add : Depreciation		50000	50000	50000	50000	50000
Add : Salvage Value						50000
Cash Flows	300000	63000	63000	63000	63000	113000

(b.) Calculation of accounting rate of return based on original investment

Calculation of ARR (Accounting Rate of Return ) = Annual Net Income / Initial Investment

= 13000 / 300000

= 0.04333 or 4.333%

(c.)Calculation of accounting rate of return based on Average Investment investment

Calculation of ARR (Accounting Rate of Return ) = Annual Net Income / [(Initial Investment + Salvage Value)/ 2 ]

= 13000 / [(300000 + 50000)/2]

=13000 / 175000

= 0.0743 or 7.43%