Chapter 11 Problems

Topics: Net present value, Investment, Internal rate of return Pages: 3 (653 words) Published: November 29, 2012
I. Payback period computation; even cash flows
Compute the payback period for each of the following two separate investments (round the payback period to two decimals): 1. A new operating system for an existing machine is expected to cost $260,000 and have a useful life of five years. The system yields an incremental after-tax income of $75,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000. Payback period=Cost of investment/ Annual net cash flow

=$260,000/ $125,000
=2.08 years

Annual depreciation= $260,000 -$10,000 / 5
= $50,000

Annual after tax income $75,000
+ Depreciation 50,000
Annual net cash flow$125,000

2. A machine costs $190,000, has a $10,000 salvage value, is expected to last nine years, and will generate an after-tax income of $30,000 per year after straight-line depreciation. Payback period=Cost of investment/ Annual net cash flow

=$190,000/ $50,000
=3.8 years

Annual depreciation= $190,000 -$10,000 / 9
= $20,000

Annual after tax income $30,000
+ Depreciation 20,000
Annual net cash flow$50,000

II. Payback period computation; uneven cash flows
Wenro Company is considering the purchase of an asset for $90,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the payback period for this investment.

Part of year= Amount paid back in year 4/ Net cash flows in year 4
= $10,000 / $60,000
= 0.167

Payback period=3 + 0.167
= 3.1367 years
= 3yrs 2 mos.

III. Accounting Rate of Return
A machine costs $500,000 and is expected to yield an after-tax net income of $15,000 each year. Management predicts this machine has a 10-year service life and a $100,000 salvage value, and it uses straight-line depreciation. Compute this machine’s accounting rate of return. Average investment=$500,000 + $100,000 / 2

= $300,000

Accounting rate of return...
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