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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

Capital rationing decision involving four proposals

Kopecky Industries Inc. is considering allocating a limited amount of capital investmentfunds among four proposals. The amount of proposed investment, estimated income fromoperations, and net cash flow for each proposal are as follows

The company’s capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on allprojects. 1f the preceding standards are met, the net present value method and presentvalue indexes are used to rank the remaining proposals.

Instructions
Compute the cash payback period for each of the four proposals. Assume that net cashflows are uniform throughout the year.

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.

To Calculate:

The Payback Period for each proposal

Explanation

The Payback Period for each proposal is calculated as follows:

    Proposal SierraNet Cash Flows Accumulated Net Cash Flows
    Year 0 $ (850,000) $ (850,000)
    Year 1 $ 250,000 $ (600,000)
    Year 2 $ 250,000 $ (350,000)
    Year 3 $ 250,000 $ (100,000)
    Year 4 $ 200,000 $ 100,000
    Year 5 $ 100,000 $ 200,000
    Payback Period (Years) 3.50
    3 + (100000/200000)
    Proposal TangoNet Cash Flows Accumulated Net Cash Flows
    Year 0 $ (1,200,000) $ (1,200,000)
    Year 1 $ 560,000 $ (640,000)
    Year 2 $ 540,000 $ (100,000)
    Year 3 $ 400,000 $ 300,000
    Year 4 $ 300,000 $ 600,000
    Year 5 $ 220,000 $ 820,000
    Payback Period (Years)2...

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