Question

The management of Nebraska Corporation is considering the purchase of a new machine costing $490,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation:
Year Income from Operations Net Cash Flow
1 $100,000 $180,000
2 40,000 120,000
3 40,000 100,000
4 10,000 90,000
5 10,000 120,000
1) The cash payback period for this investment is:

a) 5 years

b) 4 years

c) 2 years

d) 3 years

2) The average rate of return for this investment is:

a) 18%

b) 16%

c) 58%

d) 10%

Answer 1

Answer:

b) 4 years

b) 16%

Explanation:

The computation of cash payback period for this investment is shown below:-

Year     Net Cash Flow      Cumulative Net Cash Flow

1             $180,000               $180,000

2            $120,000                $300,000

                                    ($180,000 + $120,000)

3             $100,000               $400,000

                                    ($300,000 + $100,000)

4             $90,000                $490,000

                                    ($400,000  + $90,000)

5             $120,000               $610,000

                                     ($490,000 + $120,000)

The period of payback is the duration in which the investment is recovered. Investment amounts to $490,000 and the cumulative net cash flow after 4 years is $490,000. So, the payback period is 4 years.

Year       Income from Operations

1               $100,000

2              $40,000

3              $40,000

4              $10,000

5              $10,000

Total         $200,000

Average Income = $200,000 ÷ 5

= $40,000

Average Investment = ($0 + $490,000) ÷ 2

= $245,000

Average Rate of Return = Average Income ÷ Investment × 100

= $40000 ÷ $245000 × 100

= 16.33%

or

= 16%