Question

Question 2: Calculate the Payback Period. Shall investment be accepted target payback period is 3 years? (25 marks) Question 3: Calculate Average Accounting Return (AAR) for the Famous Company. Shall investment be accepted if target rate of return is 19%? (15 marks)

Answer 1

ANSWER

1. Calculation of payback period of the projecte

YEAR	CASH FLOW	CUMULATIVE CASH FLOW
1	235000	235000
2	280000	515000
3	325000	840000
4	370000	1210000
5	365000	1575000

Payback period = 3 years + [(Initial outflow - cumulative cash flow of 3^rd year) / Cash flow of 4^th year]

= 3 years + [(850000-840000) / 370000]

= 3 years + 0.027 years

Payback period = 3.027 year or 3 years & 0.32 months (approx.)

Decision - As target payabck period is 3 years but actula payback period of the project it 3.027 years hence projcet should not accepted

2.Calculation of average rate of return

Avrage net income = net income of the each year / number of years

= (85000+130000+175000+220000+215000) / 5 years

= 825000 / 5 years

Avg. net income = 165000

Avg. rate of return = Avg. net income / cost of the project

= 165000 / 850000

Avg. rate of return = 19.41%

Decision- As rate of return of the project is more than target rate of return i.e. 19%, hence project should be accepted