Chapter 3: Capital Budgeting Flashcards
3 Financing Coverage
- Investment Decision
- Financing Decision
- Dividend Decision
May be defined as decision-making, firms evaluate purchased of major-fixed assets (building, machinery and equipment). To determine required return from a project.
Capital Budgeting
Significance of Capital Budgeting
- Long term effects
- Timing the availability of Capital assets
- Quality of capital assets
- Raising funds
- Ability to compete
Some Difficulties in Capital Budgeting
- Measurement problem
- Uncertainty
Project classifications
- Mandatory investment
- Replacement
- Expansion project
- Diversification project
- Research & Development projects
Capital budgeting evaluation techniques
- non-discounting methods
- Discounting method
Non-discounting methods
- Urgency
- Payback period
- Accountng rate of return
Discounting methods
- Net Present Value
- Profitability Index
- Internal Rate of return
It refer to the length of period required to recover the cost of investment
Payback period
Formula of Payback period
Intial cost of investment / Annual cash inflow
Find Payback Period
Given:
Year 0 = 5,000,000
Year 1 = 2,000,000
Year 2 = 2,500,000
Year 3 = 3,500,000
Year 4 = 2,000,000
Year 5 = 2,000,000
Year 1 = 2,000,000 = 1
Year 2 = 2,500,000 = 1
Year 3 = (5,0000,000 - 4,500,000) / 3,500,000 = 0.14
PP = 2.14 years
Find Payback Period
Given:
Intial Capital = 3,000,000
Year 1 = 1,200,000
Year 2 = 1,200,000
Year 3 = 1,200,000
Year 4 = 1,200,000
Year 5 = 1,200,000
Year 1 = 1,200,000 = 1
year 2 = 1,200,000 = 1
Year 3 = (3,000,000-2,400,000) / 1,200,000 = 0.5
PP =. 2.50 years
Find Payback Period
Given:
Intial Capital = 30,000,000
Year (1-5) = 5,000,000 per year
Year (6-10) = 6,000,000 per year
Year 1 - 5 = 25,000,000 (5M x 5 years) = 5
Year 6 = 5,000,000 / 6,000,000. = 0.83
PP = 5.83 years
Formula of Accounting rate of return (ARR)
Average income after tax / Initial cost of investment
Formula of Net Present Value
Present Value of Cash Inflows - Present Value of Cash outflow
Formula of Profitability Index
Present value of cash inflow (PVCI) / Initial cost of investment
Find Payback Period
Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000
Year 1 = 300,000 = 1
Year 2 = 350,000 = 1
Year 3 = (800K- 300K - 350K) / 450,000 = 0.33
Answer = 2.33 years
Find Net Present Value
Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000
Rate = 8%
Year 1 = 300,000 x 0.9259 = 277,770
Year 2 = 350,000 x 0.8573 = 300,055
Year 3= 450,000 x 0.7938 = 330, 210
Year 4 = 500,000 x 0.7350 = 367,500
Year 5 = 800,000 x 0.6806 = 544,480
(PVCI) 1,847,015 - (PVCO) 800,000
NPV = 1,047,015
Find Profitability Index
Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000
Rate = 8%
PI= 1,847,015 / 800,000
= 2.31
Find Discounted Payback Period
Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000
Rate = 8%
Notebook
2020
Gross Sales = 800,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 120,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?
2021
Gross Sales = 1,200,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 150,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?
2020
Gross Sales = 800,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 120,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?
2021
Gross Sales = 1,200,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 150,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?
Find Accounting Rate of Return
Initial Investment = 1,500,000
Income After Tax = 273,000 (Year 1)
448,000 (Year 2)
ARR = ((273,000 + 448,000) / 2) / 1,500,000
= 24.03%
Find Internal rate of Return
Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000
Rate = 8%
No need to study since it will not come out on the exam
IRR = 42.23%
Find Internal rate of return
Given:
Intial Capital = (350,000)
Year 1 = 100,000
Year 2 = 200,000
Year 3 = 220,000
Year 4 = 80,000
Rate of Return = 18%
Found in notebook
Find NPV (use excel)
Given:
Intial Capital = (20,000,000)
Year 1 = 5,000,000
Year 2 = 8,000,000
Year 3 = 8,500,000
Year 4 = 7,000,000
Year 5 = 8,000,000
Year 6 = 6,000,000
Required rate of Return = 20%
Year 1 = 5,000,000 x 0.8333 = 4,166,500
Year 2 = 8,000,000 x 0.6944 = 5,555,200
Year 3 = 8,500,000 x 0.5787 = 4,918,950
Year 4 = 7,000,000 x 0.4823 = 3,376,100
Year 5 = 8,000,000 x 0.4019 = 3,215,200
Year 6 = 6,000,000 x 0.3349 = 2,009,400
(PVCI) 23,241,350 - (PVCO) (20,000,000)
NPV =
Find IRR (use excel)
Given:
Intial Capital = (20,000,000)
Year 1 = 5,000,000
Year 2 = 8,000,000
Year 3 = 8,500,000
Year 4 = 7,000,000
Year 5 = 8,000,000
Year 6 = 6,000,000
Required rate of Return = 20%
Found in Excel
Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the:
a. Payback period
Found in Test #2
Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the:
b. Net Present Value (16%)
Found in Test #2
NPV= 13,030,800 - 8,700,000 = 4,330,800
Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the:
c. Profitability Index
Found in Test #2
Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the:
d. Discounted payback period (16%)
Found in Test #2
Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the:
e. Internal rate of return (16%)
Found in Test #2
IRR= 30% + (31% - 30%) x [(₱74,105.26 - 0) / (₱74,105.26 - (₱138,387.94)) ]
= 30.34874%
Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the:
f. whether to accept or reject this investment. The minimum required rate of return of the company is 16% on all capital investments.
Accept
The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12 %
Year
0 = (800,000)
1 = 300,000
2 = 350,000
3 = 300,000
4 = 250,000
5 = 250,000
Find the:
a.) Payback period
Found in Test #2
The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12%
Year
0 = (800,000)
1 = 300,000
2 = 350,000
3 = 300,000
4 = 250,000
5 = 250,000
Find the:
b.) NPV (discount rate is 12%)
Found in Test #2
NPV= 1,061,155 - 800,000
= 261,155
The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12%
Year
0 = (800,000)
1 = 300,000
2 = 350,000
3 = 300,000
4 = 250,000
5 = 250,000
Find the:
c.) Profitability Index (discount rate is 12%)
PI= 1,061,155 / 800,000
=1.32
The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12%
Year
0 = (800,000)
1 = 300,000
2 = 350,000
3 = 300,000
4 = 250,000
5 = 250,000
Find the:
b.) IRR (discount rate is 12%)
Found in Test #2
The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12%
Year
0 = (800,000)
1 = 300,000
2 = 350,000
3 = 300,000
4 = 250,000
5 = 250,000
Find the:
e.) Will you recommend for the acceptance of the project?
Accept
For a project that has an initial investment of P8.7 million, your client has asked you to determine the accounting rate of return. The data are the following:
- Sales revenue: 30M (2022)
- Cost of Cost: 40%
- Interest Expense: 16% of the outstanding debt of P5,000,000
- Tax rate: 30%
- Operating expenses as 10M
- It was learned that the income after tax in the preceding year was 10% lower than this year, 2022
Found in Test #2
ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project:
Year 1 = P50M
Year 2 = P100M
Year 3 = P150M
Year 4-15 = P200M per year
Given the information, this client asked you to provide the following:
a.) Payback period of the project
Found in ME
PP= 5.5 years
ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project:
Year 1 = P50M
Year 2 = P100M
Year 3 = P150M
Year 4-15 = P200M per year
Given the information, this client asked you to provide the following:
b.) Net Present Value (WACC = 15%)
NPV= ₱130,549,058.77
ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project:
Year 1 = P50M
Year 2 = P100M
Year 3 = P150M
Year 4-15 = P200M per year
Given the information, this client asked you to provide the following:
c.) Discounted payback period
PP= 10.82 years
ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project:
Year 1 = P50M
Year 2 = P100M
Year 3 = P150M
Year 4-15 = P200M per year
Given the information, this client asked you to provide the following:
d.) Profitability Index
PI= 930,555,000 / 800,000,000
= 1.16
ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project:
Year 1 = P50M
Year 2 = P100M
Year 3 = P150M
Year 4-15 = P200M per year
Given the information, this client asked you to provide the following:
e.) Internal rate of return
=17% + (18% - 17%) x [(₱32,362,435.20 -0) / (₱32,362,435.20-(₱11,053,118.88))]
= 17.75%
Purchases of long-term operational asset.
Capital Investment
Once purchased, company is committed to these investments for an extended period of time.
Capital Investment
A decision to exchange current cash outflows for the expectation of receiving future cash inflows
Capital Investment Decisions
Understanding the time value of money concept will help you make a rational capital investment decision.
Capital Investment Decisions
are concerned with:
- The process of planning
- Setting goals and priorities
- Arranging financing
- Using certain criteria to select long-term assets
Capital Investment Decisions
money invested in a business venture with a thought of income and amount is expected to be recovered through earnings generated by the business over a period of time.
Capital investment
funds invested in a firm or enterprise for the purpose of furthering its business goals and objectives.
Capital investment
seeks to build on the future value of money which may be spent now.
Capital budgeting
Uses techniques and looks into the different factors that can aid in making decision.
Capital budgeting
Creates accountability and measurability of a business plan.
Capital budgeting
The process of making capital investment decisions
Capital budgeting
Types of capital budgeting projects
- Independent projects
- Mutually exclusive projects
Projects that, if accepted or rejected, will not affect the cash flows of another project.
Independent projects
Projects that, if accepted, preclude the acceptance of competing projects.
Mutually exclusive projects
Guidelines for Capital Budgeting
- Use Cash Flows rather than Book Profits
- The basis for evaluating the attractiveness of a proposal is incremental cash flow
- Consider Incidental or Synergistic Effects
- Avoid Cash flow diverted from existing product
- Consider Incremental Expenses
- Consider Opportunity cost
Administration of Capital Investment Decisions
- Generation of investment proposal
- Estimation of cash flows
- Evaluation of cash flows and selections of projects
How to get Initial Investment
= Cost of asset + installation cost + working capital investment – sales from old asset + taxes on sale of old asset
Evaluation Methods
- Payback Period
- Average Rate of Return
- Net Present Value
- Internal Rate of Return
- Profitability Index or Benefit-cost ratio
length of time required for the firm to recover initial investment using cash flow basis
payback period
if the payback period is less or is the company’s payback period then _______ the project
accept
simple and easy but ignores timing and magnitude of inflow
Payback period
Formula of payback period
= Net cost of investment / Annual net cash inflows
- Help control the risks associated with the uncertainty of future cash flows.
- Help minimize the impact of an investment on a firm’s liquidity problems.
- Help control the risk of obsolescence.
- Help control the effect of the investment on performance measures.
Payback period
- Ignores the time value of money
- Ignores the performance of the investment beyond the payback period
Payback period
also known as accounting rate of return
Average Rate of Return
Divides project’s average profit after taxes by investment
Average Rate of Return
the average rate of return is compared with the minimum or required rate.
Average Rate of Return
If the ARR exceeds the required, the project is _________
accepted
Formula of Accounting Rate of Return
= Average income / Original investment or Average investment
Formula of getting average income
Average annual net cash flows, less average depreciation
Formula of getting Average investment
= (I + S) ÷ 2
One of the discounted cash flow method where the difference between the present value of cash inflows and outflows
Net Present Value
Potential change in an investor’s wealth caused by that project/proposal with the consideration of the time value of money
Net Present Value
Decision rule: _______ a project if its NPV is positive and ______ if its NPV is negative
accept; reject
Decision Criteria for NPV
If NPV > 0:
- The initial investment has been recovered
- The required rate of return has been recovered
Formula of When cash inflows are even:
NPV = R × [1 − (1 + i)-n / i] − Initial Investment
What is the following terms when cash flows are even:
R = ?
I = ?
N = ?
R =net cash inflow to be received in each period
I =required rate of return per period
N = number of periods during which the project is expected to operate and generate cash inflows
Formula of when cash flows are uneven
= [ R1/ (1 + i)^1 + R2 /(1 + i)^2 + R3 /(1 + i)^3 + …..] - Initial Investment
In cahs flows are uneven where:
I = ?
R1 = ?
R2 = ?
R3 = ?
I = target rate of return per period;
R1 = net cash inflow during the first period;
R2 = net cash inflow during the second period;
R3 = the net cash inflow during the third period, and so on …
is the rate at which the present value of cash inflows equals cash outflows.
Internal Rate of Return
The rate that will produce a zero NPV.
Internal Rate of Return
Discount rate at which the NPV of an investment becomes zero
Internal Rate of Return
The discount rate which equates the PV of the future cash flows of an investment with the initial investment
Internal Rate of Return
________ if IRR is not less than the target rate of return or choose which project has the highest value of IRR
accept
Decision Criteria:
If the IRR > Cost of Capital, _____________
If the IRR = Cost of Capital, ______________
If the IRR < Cost of Capital, ____________
If the IRR > Cost of Capital, accept the project
If the IRR = Cost of Capital, accept or reject
If the IRR < Cost of Capital, reject the project
Formula for IRR
NPV = 0
Or
PV of future cash flows – initial investment = 0
or
[ R1/ (1 + i)^1 + R2 /(1 + i)^2 + R3 /(1 + i)^3 + …..] - Initial Investment = 0
The simplest way of finding IRR:
- Guess the value of r and calculate the NPV of the project at that value.
- If NPV is close to zero then IRR is equal to r.
- If NPV is greater than 0 then increase r and jump to step
- If NPV is smaller than 0 then decrease r and jump to step
- Recalculate NPV using the new value of r and go back to step 2.
Is a relative measure as it gives the figure as a ratio
Profitability Index/benefit-cost ratio
Helps in ranking projects based on their per dollar return
Profitability Index/benefit-cost ratio
Decision rule:
_________ if the profitability index is greater than 1,
____________ if it is zero
__________ if it is below 1
accept if the profitability index is greater than 1;
stay indifferent if it is zero;
don’t accept if it is below 1
Formula of Profitability Index/benefit-cost ratio
= Present Value of Future Cash Flows / Initial Investment Required
= 1 + (Net Present Value
/ Initial Investment Required)
Find the ARR
Project Cost: Php 2M
Estimated life: 5 yrs
Estimated net income:
1 = 200,000
2 = 250,000
3 = 200,000
4 = 300,000
5 = 550,000
Found in notes
Calculate the net present value of a project which requires an initial investment of $243,000 and it is expected to generate a cash inflow of $50,000 each month for 12 months. Assume that the salvage value of the project is zero. The target rate of return is 12% per annum.
NPV= 319,753.87
Diamond Corporation is planning to buy a new equipment which costs Php 10M, estimated life of 10 years with no salvage value. The installation cost is Php 1,500,000 with an additional working capital of Php 100,000. There is Php 5M existing equipment of four years with a depreciable life of 8 years. This equipment can be resold for Php 3,250,000. Existing income tax rate is 35%.
Found in notes
Payback analysis
Unrecovered Investment
Year 1 = $200,000
Year 2 = 140,000
Year 3 = 60,000
Year 4 =
Year 5 =
Annual Cash Inflow
Year 1 = $60,000
Year 2 = 80,000
Year 3 = 100,000
Year 4 = 120,000
Year 5 = 140,000
Found in notes
An initial investment of Php 1,000 on plant and machinery is expected to generate cash inflows of 500, 400, 200, 200, and 100 at the end of first, second, third, fourth, and fifth year respectively. Calculate the net present value of the investment if the discount rate is 10%.
Found in notes
Find the IRR of an investment having initial cash outflow of $213,000. The cash inflow during the first, second, third, and fourth years are expected to be $65,200, $96,000, $73, 100 and $55,400 respectively. Assume that r is 10%.
Found in notes
Profitability index
An initial investment of Php 1,000,000 with projected annual ash inflow of Php 400,000 for 10 years at 25% required rate of return yields a present value of cash inflows of Php 1,319,410
Found in notes
Star Corporation is planning to buy a new equipment which costs Php 500,000 estimated life of 5 years with no salvage value. The installation cost is Php 75,000 with an additional working capital of Php 100,00. The is a Php 200,000 existing equipment of three years with a depreciable life of 5 years. This equipment can be resold for Php 150,000. Existing income trax rate is 35%.
- Initial Investment =
(Cost of asset) Php 500,000.00
+ (Installation cost) 75,000.00
+ (working capital investment) 100,000.00
– (sales from old asset) 150,000.00
+ (taxes on sale of old asset) 24,500.00
Initial investment Php 549,500.00
Taxable gains from sales
Sales price of old asset = 150,000.00
Less BV: 200,000(2/5) = 80,000.00
Gains = 70,000.00
= 35%
Tax on sale of old = Php 24,500.00
A company is planning to invest in a project that requires Php 500,000 initial investment and is expected to provide annual after-tax inflow of Php 100,000. Company’s acceptable maximum payback period is 6 years. Will the company pursue their plan on this project?
Payback period = 500,000 / 100,000 = 5 years
Since 5 is lesser than 6, accept the project
An initial investment of Php 8,320 with Php 900.00 salvage value on plant and machinery is expected to generate cash inflows of Php 3,411, Php 4,070 , Php 5,824 and Php 2,065 at the end of first, second, third and fourth year respectively. Calculate the net present value of the investment if the discount rate is 18%.
Total PV in Cash Inflows = 10,887.67
Less: Intitial Investment = 8,320
NPV = 2,567.67
Accept the project
The management of N marketing is considering the purchase of a new machine costing P300,000 with a salvage value of P100,000. The asset is expected to have an additional inflow of P35,000 annually for 5 years. The company’s desired rate of return is at 10%. Using ARR, will the company push with the purchase of the new machine?
Average Rate of Return
= 35,000/200,000
=17.5% , accept
The average rate of return is compared with the minimum or required rate.
17.5% > 10%
Note: If the ARR exceeds the required, the project is accepted
Country Store is looking into purchasing a sea van as a storage van for years. The cost of the sea van is at P1,400,000 with salvage value of P50,000. Below is the estimated net income for 5 years. Country Store uses ARR in evaluating capital investment and have set their required rate of return at 30%. What will you recommend. Support your recommendation.
Estimated net income:
1 = Php 150,000
2 = 250,000
3 = 200,000
4 = 300,000
5 = 550,000
total income = 1,450,000
= 290,000/ 725,000 =40%
: Accept
Calculate the net present value of a project which requires an initial investment of P900,000 and it is expected to generate a cash inflow of P400,000 for 10 years. The target rate of return is 30% per annum.
NPV = 400,000 × 1 − (1 + 30%)-10 − 900,000
=400,000 × 3.0915 − 900,000
=336,615.80
An initial investment of P50,000 on plant and machinery with salvage value of P13,000 is expected to generate cash inflows of P12,500; P23,400; P12,200; P25,200; P1,100 at the end of first, second, third, fourth, and fifth year respectively. Calculate the net present value of the investment if the discount rate is 10%.
Found in notes
ABC corporation plans to purchase a piece of factory equipment for P300,000 with a scrap value of P10,000 at the end of its life. The equipment would only last three years, but it is expected to generate P150,000 of additional annual profit. Factory equipment is expected to have a return of 15%.
At 15%
=(130,434.783 + 113,421.55 + 105,202.597) -300,000
=349,058.93 – 300,000
= 49,058.93
If NPV is greater than 0 then increase r
If NPV is smaller than 0 then decrease r
At 25%
= (120,000 + 96,000 + 81,920) – 300,000
= -2080
Decision rule: accept if IRR is not less than the target rate of return or choose which project has the highest value of IRR
Accept the project.
Capital investment decisions often involve all of the following except ________.
a. qualitative factors or considerations
b. short periods of time
c. large amounts of money
d. risk
b. short periods of time
Preference decisions compare potential projects that meet screening decision criteria and will be ranked in their preference order to differentiate between alternatives with respect to all of the following characteristics except ________.
a. political prominence
b. feasibility
c. desirability
d. importance
a. political prominence
The third step for making a capital investment decision is to establish baseline criteria for alternatives. Which of the following would not be an acceptable baseline criterion?
a. payback method
b. accounting rate of return
c. internal rate of return
d. inventory turnover
You are explaining time value of money factors to your friend. Which factor would you explain as being larger?
a. The future value of $1 for 12 periods at 6% 6 % is larger.
b. The present value of $1for 12 periods at 6%
c. Neither one is larger because they are equal.
d. There is not enough information given to answer this question.
Bob’s Auto Repair has determined that it needs new lift equipment to acquire more business opportunities. However, one or more alternatives meet or exceed the minimum expectations Bob has for the new lift equipment. As a result, what type of decision should Bob make for his company?
If a copy center is considering the purchase of a new copy machine with an initial investment cost of $150,000 and the center expects an annual net cash flow of $ 20,000 per year, what is the payback period?
Payback period=initial cost/annual cash flows
=150,000/20,000
which is equal to
=7.5 years
Assume a company is going to make an investment of $450,000 in a machine and the following are the cash flows that two different products would bring in years one through four. Which of the two options would you choose based on the payback method?
Option A, Product A Option B, Product B
$190,000 $150,000
190,000 180,000
60,000 60,000
20,000 70,000
Option A
Payback period
= (3 years + (10000/20000))
= 3.5 Years
Option B
Payback period
= (3 years + (60000/70000))
= 3.86 Years
If a garden center is considering the purchase of a new tractor with an initial investment cost of $120,000 and the center expects a return of $30,000
in year one, $20,000 in years two and three, $15,000 in years four and five, and $10,000 in year six and beyond, what is the payback period?
Payback period = 7 Years
The management of Kawneer North America is considering investing in a new facility and the following cash flows are expected to result from the investment:
Initial Cash Outflow:
Year 1= $1900000
Year 2 =$550000
Initial Cash Inflow
Year 1 = $100.000
Year 2 =200.000
Year 3 =360.000
Year 4 =480.000
Year 5 =510.000
Year 6 =600.000
Year 7 =590.000
Year 8 =300,000
Year 9 =250.000
Year 10 =250.000
a. What is the payback period of this uneven cash flow?
b. Does your answer change if year 10 ’s cash inflow changes to $500,000 ?
a.) In Year 7 the Cummulative Cash Inflow is $2840,000
Hence Payback Period
= 6 + ($2450000 $2250000)/$590,000
= 6 + $200,000/590000
= 6.34 years
b) No, the answer will not change as the payback period is less than 10 years.
A mini-mart needs a new freezer and the initial investment will cost $300,000. Incremental revenues, including cost savings, are $200,000 , and incremental expenses, including depreciation, are $125,000. There is no salvage value. What is the accounting rate of return (ARR)?
