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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Cash payback period, net present value method, and analysis

McMorris Publications Inc. is considering two new magazine products. The estimated netcash flows from each product arc as follows:

Each product requires an investment of $400000. A rate of 10% has been selected forthe net present value analysis.

Instructions

Prepare a brief report advising management on the relative merits of each of the twoproducts.

To determine

Concept Introduction:

Capital budgeting is a technique to plan long term investment of funds in long term activities whose benefit released for several years.

Example: - Purchase of machineries, purchase of building for business purpose, setting of factories etc.

Cash payback period refers to the period in which entire cost of project introduced is expected to realize by way of cash inflows.

Net Present value refers to the difference between the present value of inflows and the present value of outflows associated with the projects.

To Indicate:

The advice to the management

Explanation

Calculation of Payback Period

  1. In case of equal cash inflows
  2. Payback Period = Total Cash Outflow /Annual Cash Inflow
  3. In case of unequal Cash Inflows
  4. Payback Period = Years up to cumulative Cash inflow is less than total Cash Outflow + (Total cash Outflow-Cumulative cash Inflow of the year in which cumulative cash flows is less than total cash flow)/Cash flows immediately succeeding the year in which cumulative cash flows is less than total cash flow

In the present case

Given,

Present value of Outflow = $ 400,000

Present value of unequal cash Inflows as follows

    Years 12345
    Canadian Cycling$ 220,000$ 180,000$ 158,000$ 131,000$ 61,000
    European Hiking$ 188,000$ 212,000$ 150,000$ 110,000$ 90,000
    YearsCanadian CyclingCumulativeEuropean HikingCumulative
    (Cash Inflow)cash inflow(Cash Inflow)cash inflow
    12,20,0002,20,0001,88,0001,88,000
    21,80,0004,00,0002,12,0004,00,000
    31,58,0005,58,0001,50,0005,50,000
    41,31,0006,89,0001,10,0006,60,000
    561,0007,50,00090,0007,50,000

Payback Period

For Canadian Cycling

Payback period=2 years

For European Hiking

Payback period=2 years

In the above both cases Cash payback period is 2 years as total cash outflow is recovered at the end of 2nd year...

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