Question

How do the payback and accounting rate of return methods work? If the amount invested is $100,000 and the yearly expected cash flows are $20,000 per year, what is the payback period? If the amount invested is $100,000, the residual value is $20,000 and the average annual operating income is $10,000, what is the ARR? What is the time value of money? Using the tables provided in Appendix A, if the future value of an investment five years from now needs to be $10,000, what is the present value? Assume the interest rate is 6%.

Answer 1

a	Calculation of Payback period :-
a	Initial Investment	=	$          100,000
b	Estimated cash flows	=	$            20,000
c	Payback period (years) (a/b)	=	5.00
b	Calculation of Accounting rate of return:-
	Accounting rate of return	=	Average Annual Net Income
			Average Book Value
a	Average Annual Net Income		$            10,000
b	Average Book value ((100000+20000)/2)		$            60,000
c	Accounting rate of return (ARR) (a/b *100)		16.67%
c	Calculation of Present value:-
a	Future value of an investment five years from now		$        10,000
b	Present value factor at 6% for 5 years		0.74726
c	Present value (a*b)		$     7,472.58

Feel free to ask any clarification, if required. Please provide feedback by thumbs up, if satisfied. It will be highly appreciated. Thank you.