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

accounting rate of return = average net income / average investment *100

here,

average net income = 22,500

average investment = (initial investment + salvage value )/2

here, salvage value = $75,000 initial investment - ($6500 annual depreciation * 10 years)

=>$10,000

average investment=>(75,000+10,000)/2

=>42,500

accounting rate of return = 22,500 / 42,500 *100

=>52.94%.

Payback period for constant annual cash flows= initial investment/(net income + depreciation)

=> 75,000 /(22500+6500)

=>75,000/29,000

=>2.59 years.

Since the accounting rate of return is high and payback period is 2.59 years, which is less than the project timeline of 10 years, the project is feasible.