Question

The initial investment and other related data of Company K are given below ($000):
Initial investment : 75,000
Economic life: 10 years
Annual net incomes: 22,500
Annual depreciation: 6,500

Calculate the ARR and Payback period and comment on the feasibility of investment   

Answer 1

A) ARR = average net income / initial investment × 100

= 22,500 / 75,000 × 100

= 0.30 × 100

= 30%

B) Payback period

In case of payback period, we need cash flow instead of net income

Cash flow = net income + depreciation

= 22,500 + 6,500

= 29,000

Years	Cash flow	Cumulative cash flow
0	-75,000	-75,000
1	29,000	-46,000
2	29,000	-17,000
3	29,000	12,000
4	29,000	41,000
5	29,000	70,000
6	29,000	99,000
7	29,000	128,000
8	29,000	157,000
9	29,000	186,000
10	29,000	215,000

Payback period= Year becore the payback occurs + cummulative cash flow in the year before recovery/ cash flow in the year after recovery

= 2 + 17,000/29,000

= 2 + 0.59

= 2.59 years