Question

Payback Period and Accounting Rate of Return: Equal Annual Operating Cash Flows with Disinvestment
Roopali is considering an investment proposal with the following cash flows:

Initial investment-depreciable assets	$39,000
Initial investment-working capital	6,000
Net cash inflows from operations (per year for 6 years)	9,000
Disinvestment-depreciable assets	3,000
Disinvestment-working capital	2,000

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

a. Determine the payback period.
Answer

years

b. Determine the accounting rate of return on initial investment
Answer

c. Determine the accounting rate of return on average investment
Answer

Answer 1

Answer-a)- Pay-back period = Total initial investments/Annual net cash inflows

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

= ($39000+$6000)/$9000

= $45000/$9000

= 5 years

b)- Accounting rate of return on initial investment = (Annual net profit/Total Initial Investment)*100

= ($3000/$45000)*100

= 6.667%

Explanation- Annual Net Profit = Annual cash inflows – Annual depreciation

= $9000 - $6000

= $3000

Where- Annual depreciation = (Investment in depreciable assets - Disinvestment depreciable assets)/useful life

= ($39000-$3000)/6 years

= $36000/6 years

= $6000

c)- Accounting rate of return on average investment = (Annual net profit/Average Investment)*100

= ($3000/$25000)*100

= 12%

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

= ($39000+$6000+$3000+$2000)/2

= $50000/2

= $25000

Annual net profit = $3000