Payback and accounting rate of return

Companies use capital investment analysis to evaluate long-term investments. Capital investment evaluation methods that do not use present values are (1) Average rate of return method and (2) Cash payback method.

Non-Discounting Models

One type of model used to assess the viability of a potential capital investment is known as a non-discounting model. The primary difference between a discounting model and a non-discounting model is that the latter Selectdoesdoes notCorrect 1 of Item 1 take the time value of money into account. The basic premise of the time value of money is that a dollar today is worth Selectless thanmore thanthe same asCorrect 2 of Item 1 a dollar tomorrow.

True or False: Considering the fact that most firms use both discounting and non-discounting models, it can be concluded that both models have value. SelectTrueFalseCorrect 3 of Item 1

Payback Period

This is one useful non-discounting method for evaluating capital investment decisions. The particulars of the method vary depending on whether the cash flows from an investment are even or uneven. The primary information transmitted by the payback period method is how long it will take (in years) to recover the Selectinitial investmentrequired returntotal profitCorrect 1 of Item 2.

Payback Period (Even cash flows)

Suppose that a particular investment required an up-front capital outlay of $100,000. This investment is expected to yield cash flows of $25,000 per year for 10 years. What is the payback period for this investment? If required, round your answer to two decimal places.

Formula: Payback Period = Initial Investment/Annual Cash Flow

Payback Period = $ / $ = years

Accounting Rate of Return

The accounting rate of return is another non-discounting financial model commonly used in making capital investment decisions. Unlike the payback period model, the accounting rate of return uses income rather than cash flow.

Assume that the investment is the same as before: Initial outlay of $100,000 with a five-year useful life and no salvage value under straight-line depreciation. The revenues are as follows: ( Year 1: $50,000, Year 2: $30,000, Year 3: $40,000, Year 4: $20,000 and Year 5: $10,000.)

Use the minus sign to indicate a net loss. If an amount is zero, enter "0". If required, enter the accounting rate of return as a decimal (i.e. 0.3).

Year		Revenues		Expenses		Net Income
Year 1 Net Income (loss)	=	$50,000	-	$20,000	=	$
Year 2 Net Income (loss)	=		-		=
Year 3 Net Income (loss)	=		-		=
Year 4 Net Income (loss)	=		-		=
Year 5 Net Income (loss)	=		-		=

Total Net Income (five years) = $

Average Net Income =

$

= $

Accounting Rate of Return =

$

=