Chapter 26, Problem 2BPSB

To determine

Concept Introduction:

Payback Period:

Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows:

  $PaybackPeriod=\frac{InitialInvestment}{AnnualCash\inf low}$

ARR:

Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

Requirement-1:

To Calculate:

The Annual net cash flows for each project

Answer to Problem 2BPSB

The Annual net cash flows for each project are as follows:

	Project A	Project B
Annual Expected Net Cash Flows	$ 99,900	$ 105,900

Explanation of Solution

The Annual net cash flows for each project are calculated as follows:

	Project A	Project B
Net Income	$ 39,900	$ 25,900
Add: Depreciation Expense	$ 60,000	$ 80,000
	(240000/4)	(240000/3)
Annual Expected Net Cash Flows	$ 99,900	$ 105,900

To determine

Concept Introduction:

Payback Period:

Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows:

  $PaybackPeriod=\frac{InitialInvestment}{AnnualCash\inf low}$

ARR:

Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

Requirement-2:

To Calculate:

The Payback period for each project

Answer to Problem 2BPSB

The Payback period for each project is as follows:

	Project A	Project B
Payback period	2.40	2.27

Explanation of Solution

The Payback period for each project is calculated as follows:

	Project A	Project B
Cost of Investment (A)	$ 240,000	$ 240,000
Annual Expected Net Cash Flows (B)	$ 99,900	$ 105,900
Payback period (A/B)	2.40	2.27

To determine

Concept Introduction:

Payback Period:

Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows:

  $PaybackPeriod=\frac{InitialInvestment}{AnnualCash\inf low}$

ARR:

Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

Requirement-3:

To Calculate:

The Accounting rate of return for each project

Answer to Problem 2BPSB

The Accounting rate of return for each project is as follows:

	Project A	Project B
Accounting rate of Return	33.3%	21.6%

Explanation of Solution

The Accounting rate of return for each project is calculated as follows:

	Project A	Project B
Annual Net income (A)	$ 39,900	$ 25,900
Average Cost of Investment (B) (240000+0)/2	$ 120,000	$ 120,000
Accounting rate of Return (A/B)	33.3%	21.6%

To determine

Concept Introduction:

Payback Period:

Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows:

  $PaybackPeriod=\frac{InitialInvestment}{AnnualCash\inf low}$

ARR:

Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

Requirement-4:

To Calculate:

The Net present value for each project

Answer to Problem 2BPSB

The Net present value for each project is as follows:

	Project A	Project B
Net Present value	$ 90,879	$ 32,915

Explanation of Solution

The Net present value for each project is calculated as follows:

	Project A	Project B
Annual Expected Net Cash Flows (A)	$ 99,900	$ 105,900
Number of years	4	3
Present value of $1 annuity (8%, years) (B)	3.31210	2.57710
Present value of Cash flows (C) = A*B =	$ 330,879	$ 272,915
Cost of Investment (D)	$ 240,000	$ 240,000
Net Present value (C-D)	$ 90,879	$ 32,915

To determine

Concept Introduction:

Payback Period:

Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows:

  $PaybackPeriod=\frac{InitialInvestment}{AnnualCash\inf low}$

ARR:

Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

Requirement-5:

In which project the company should make the investment

Answer to Problem 2BPSB

The company should make the investment in Project A

Explanation of Solution

The Net present value for each project is calculated as follows:

	Project A	Project B
Annual Expected Net Cash Flows (A)	$ 99,900	$ 105,900
Number of years	4	3
Present value of $1 annuity (8%, years) (B)	3.31210	2.57710
Present value of Cash flows (C) = A*B =	$ 330,879	$ 272,915
Cost of Investment (D)	$ 240,000	$ 240,000
Net Present value (C-D)	$ 90,879	$ 32,915

Project A has the highest Net present value; hence, company should make the investment in Project A.