Financial & Managerial Accounting
Financial & Managerial Accounting
13th Edition
ISBN: 9781285866307
Author: Carl Warren, James M. Reeve, Jonathan Duchac
Publisher: Cengage Learning
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Chapter 25, Problem 25.6APR

1.

To determine

Cash payback method:

Cash payback period is the expected time period which is required to recover the cost of investment. It is one of the capital investment method used by the management to evaluate the long-term investment (fixed assets) of the business.

Average rate of return method:

Average rate of return is the amount of income which is earned over the life of the investment. It is used to measure the average income as a percent of the average investment of the business, and it is also known as the accounting rate of return.

The average rate of return is computed as follows:

Average rate of return =Estimated average annual incomeAverage investment

Net present value method:

Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is desired by the business based on the net income from the investment, and it is also called as the discounted cash flow method.

Present value index:

Present value index is a technique, which is used to rank the proposals of the business.  It is used by the management when the business has more investment proposals, and limited fund. 

The present value index is computed as follows:

Present value index =Total present value of net cash flowAmount to be invested

The cash payback period for the given proposals.

1.

Expert Solution
Check Mark

Explanation of Solution

The cash payback period for the given proposals is as follows:

Proposal A:

Initial investment=$680,000

         
 Cash payback period of Proposal A
         
 Year    Net cash flows    Cumulative net cash flows
                1       200,000           200,000
                2       200,000           400,000
                3       200,000           600,000
6 months (1)         80,000           680,000

Table (1)

Hence, the cash payback period of proposal A is 3 years and 6 months.

Working note:

1. Calculate the no. of months in the cash payback period:

No. of months = (Balance amount of intital investmentTotal cash flow for particular year)×No. of months in a year=$80,000$160,000×12 months= 6 months (1)

Proposal B:

Initial investment=$320,000

Cash payback period of Proposal B
         
 Year    Net cash flows    Cumulative net cash flows
                1            90,000           90,000
                2            90,000         180,000
 3            70,000         250,000
                4            70,000         320,000

Table (2)

Hence, the cash payback period of proposal B is 4 years.

Proposal C:

Initial investment=$108,000

Cash payback period of Proposal C
         
 Year    Net cash flows    Cumulative net cash flows
                  1       55,000            55,000
                  2       53,000          108,000

Table (3)

Hence, the cash payback period of proposal C is 2 years.

Proposal D:

Initial investment=$400,000

Cash payback period of Proposal D
         
 Year    Net cash flows    Cumulative net cash flows
                1     180,000          180,000
                2     180,000          360,000
3 months (2)       40,000          400,000
         

Table (4)

Hence, the cash payback period of proposal D is 2 years and 3 months.

Working note:

2. Calculate the no. of months in the cash payback period:

No. of months = (Balance amount of intital investmentTotal cash flow for particular year)×No. of months in a year=$40,000$160,000×12 months= 3 months (2)

2.

To determine

The average rate of return for the give proposals.

2.

Expert Solution
Check Mark

Explanation of Solution

The average rate of return for the given proposals is as follows:

Proposal A:

Average rate of investment = (Income from operationsUseful life of years)(Cost of investment2)=($240,0005 years)($680,0002)=$48,000$340,000=0.141In percentage 0.141×100 = 14.1%

Hence, the average rate of return for Proposal A is 14.1%.

Proposal B:

Average rate of investment = (Income from operationsUseful life of years)(Cost of investment2)=($20,0005 years)($320,0002)=$4,000$160,000=0.025In percentage 0.025×100 = 2.5%

Hence, the average rate of return for Proposal B is 2.5%.

Proposal C:

Average rate of investment = (Income from operationsUseful life of years)(Cost of investment2)=($142,0005 years)($108,0002)=$28,400$54,000=0.526In percentage 0.526×100 = 52.6%

Hence, the average rate of return for Proposal C is 52.6%.

Proposal D:

Average rate of investment = (Income from operationsUseful life of years)(Cost of investment2)=($300,0005 years)($400,0002)=$60,000$200,000=0.300In percentage 0.300×100 = 30.0%

Hence, the average rate of return for Proposal D is 30.0%.

3.

To determine

To indicate: The proposals which should be accepted for further analysis, and which should be rejected.

3.

Expert Solution
Check Mark

Explanation of Solution

The proposals which should be accepted for further analysis, and which should be rejected is as follows:

Financial & Managerial Accounting, Chapter 25, Problem 25.6APR , additional homework tip  1

Figure (1)

Proposals A and B are rejected, because proposal A and B fails to meet the required maximum cash back period of 3 years, and they has less rate of return than the other proposals. Hence, Proposals C and D are preferable.

4.

To determine

The net present value of preferred proposals.

4.

Expert Solution
Check Mark

Explanation of Solution

Calculate the net present value of the proposals which has 12% rate of return as follows:

Proposal C:

Financial & Managerial Accounting, Chapter 25, Problem 25.6APR , additional homework tip  2

Figure (2)

Hence, the net present value of proposal C is $62,067.

Proposal D:

Financial & Managerial Accounting, Chapter 25, Problem 25.6APR , additional homework tip  3

Figure (3)

Hence, the net present value of proposal D is $94,920.

5.

To determine

To determine:  The present value index for each proposal.

5.

Expert Solution
Check Mark

Explanation of Solution

The present value index for each proposal is as follows:

Proposal C:

Calculate the present value index for proposal C:

Present value index for proposal C = Total presest value of cash flowAmount to be invested=$170,067$108,000=1.575

Hence, the present value index for proposal C is 1.575.

Proposal D:

Calculate the present value index for proposal D:

Present value index for proposal D= Total presest value of cash flowAmount to be invested=$494,920$400,000=1.237

Hence, the present value index for proposal D is 1.237.

6.

To determine

To rank: The proposal from most attractive to least attractive, based on the present value of net cash flows.

6.

Expert Solution
Check Mark

Explanation of Solution

Proposals are arranged by rank is as follows:

Proposals  Net present value  Rank
 Proposal D  $      94,920 1
 Proposal C  $      62,067 2

Table (5)

7.

To determine

To rank: The proposal from most attractive to least attractive, based on the present value of index.

7.

Expert Solution
Check Mark

Explanation of Solution

Proposals are arranged by rank is as follows:

Proposals  Present value index  Rank
 Proposal C 1.57 1
 Proposal D 1.24 2

Table (6)

8.

To determine

To analysis: The proposal which is favor to investment, and comment on the relative attractiveness of the proposals based on the rank.

8.

Expert Solution
Check Mark

Explanation of Solution

On the basis of net present value:

The net present value of Proposal C is $62,067, and Proposal D is $94,920. In this case, the net present value of proposal D is more than the net present value of proposal C. Hence, investment in Proposal D is preferable.

On the basis of present value index:

The present value index of Proposal C is 1.57, and the present value index of Proposal D is 1.24. In this case, Proposal C has the favorable present value index, because the present value index of Proposal C (1.57) is more than Proposal D (1.24).  Thus, the investment in Proposal C is preferable (favorable).

Every business tries to get maximum profit with minimum investment. Hence, the cost of investment in Proposal C is less than the proposal D. Thus, investment in Proposal C is preferable.

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Chapter 25 Solutions

Financial & Managerial Accounting

Ch. 25 - Prob. 11DQCh. 25 - Give an example of a qualitative factor that...Ch. 25 - Average rate of return Determine the average rate...Ch. 25 - Average rate of return Determine the average rate...Ch. 25 - Cash payback period A project has estimated annual...Ch. 25 - Prob. 25.2BPECh. 25 - Prob. 25.3APECh. 25 - Prob. 25.3BPECh. 25 - Internal rate of return A project is estimated to...Ch. 25 - Prob. 25.4BPECh. 25 - Prob. 25.5APECh. 25 - Prob. 25.5BPECh. 25 - Prob. 25.1EXCh. 25 - Average rate of returncost savings Midwest...Ch. 25 - Average rate of returnnew product Galactic Inc. is...Ch. 25 - Calculate cash flows Natures Way Inc. is planning...Ch. 25 - Prob. 25.5EXCh. 25 - Cash payback method Lily Products Company is...Ch. 25 - Prob. 25.7EXCh. 25 - Prob. 25.8EXCh. 25 - Prob. 25.9EXCh. 25 - Prob. 25.10EXCh. 25 - Net present value method for a service company...Ch. 25 - Present value index Dip N' Dunk Doughnuts has...Ch. 25 - Net present value method and present value index...Ch. 25 - Average rate of return, cash payback period, net...Ch. 25 - Cash payback period, net present value analysis,...Ch. 25 - Internal rate of return method The internal rate...Ch. 25 - Prob. 25.17EXCh. 25 - Internal rate of return methodtwo projects Munch N...Ch. 25 - Prob. 25.19EXCh. 25 - Prob. 25.20EXCh. 25 - Net present value unequal lives Bunker Hill Mining...Ch. 25 - Net present value unequal lives Daisys Creamery...Ch. 25 - Prob. 25.1APRCh. 25 - Cash payback period, net present value method, and...Ch. 25 - Prob. 25.3APRCh. 25 - Prob. 25.4APRCh. 25 - Prob. 25.5APRCh. 25 - Prob. 25.6APRCh. 25 - Prob. 25.1BPRCh. 25 - Cash payback period, net present value method, and...Ch. 25 - Prob. 25.3BPRCh. 25 - Net present value method, internal rate of return...Ch. 25 - Prob. 25.5BPRCh. 25 - Capital rationing decision for a service company...Ch. 25 - Ethics in Action Danielle Hastings was recently...Ch. 25 - Prob. 25.2CPCh. 25 - Prob. 25.3CPCh. 25 - Qualitative issues in investment analysis The...Ch. 25 - Prob. 25.5CP
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  • Capital rationing decision involving four proposals Kopecky Industries Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, 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 present value index for each oldie proposals in part (4). Round to two decimal places.
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