Chapter 26, Problem P26.38CP

To determine

Payback period, Accounting rate of Return, Net Present value method and IRR:

All the above are the methods of capital budgeting which are having separate principles of deciding on which investment shall be taken up:

Payback period: This method is based on principle that the projects which recover which initial cash outflows earliest or within the company cut off limit, shall be accepted.

Accounting rate of return: This method computes the simple rate of return on the average investment involved in the projects and the projects which provides the highest return shall be accepted.

Net Present value: This method is based on principle of time value of money and takes decision on the basis of net residual cash inflows generated after deducting cash outflows of the projects during the whole life of projects. However, the present value of money shall be taken in to consideration while computing the cash inflows and outflows of different years within its life.

Internal return of return: This method also suggest the rate of return which the investment will realize after considering the present value of cash inflows and outflows. The Internal rate of return is that return where the present value of inflows is equal to outflows.

Profitability Index: Profitability index is also a proportion of present value of cash inflows and initial investment. The project with higher ratio shall be accepted over the other projects.

Requirement1-a:

The payback period of the project shall be determined.

To determine

Requirement 1-b:

The Accounting rate of return of the project shall be computed.

To determine

Requirement1-c:

The net present value of projects at 14% discount rate shall be computed.

To determine

Requirement1-d:

The Internal rate of return of the projects shall be computed.

To determine

Requirement2:

The decision on the project acceptance or rejection to be taken.