Question

Roopali is considering an investment proposal with the following cash flows:

Initial investment-depreciable assets	$60,000
Initial investment-working capital	6,000
Net cash inflows from operations (per year for 10 years)	11,000
Disinvestment-depreciable assets	5,000
Disinvestment-working capital	2,000

For parts b. and c., round answers to three decimal places, if applicable.

a. Determine the payback period.

b. Determine the accounting rate of return on initial investment

c. Determine the accounting rate of return on average investment

Answer 1

(a)

Payback Period = Total Initial Investment/Annual net cash inflows

= (Investment in depreciable assets + investment in Working capital)/Annual net cash inflows

= ($60000+$6000)/$11000 = 6 years

(b)

Accounting rate of return on initial investment = Annual net profit/Total Initial Investment

Annual Net Profit = annual cash inflows - depreciation per annum

Depreciation = (Investment in depreciable assets - Disinvestment depreciable assets)/useful life

= ($60000-$5000)/10 years = 5500 per annum

Annual Net profit = $$11000 - $5500 = $5500

therefore,

Accounting rate of return = $5500/$66000 = 8.33%

(c)

Accounting rate of return on average investment = Annual net profit/Average Investment

Average Investment = (Total Investment + Total Disinvestment)/2

= ($60000+$6000+$5000+$2000)/2 = $36500

Annual net profit = $5500

Accounting rate of return = $5500/$36500 = 15.07%