P16-30 Accounting rate of return, payback, and NPV [LO 7, 9, 10, 11] Busy Beaver
ID: 2348366 • Letter: P
Question
P16-30 Accounting rate of return, payback, and NPV [LO 7, 9, 10, 11]
Busy Beaver Corp. is interested in reviewing its method of evaluating capital expenditure proposals using the accounting rate of return method. A recent proposal involved a $50,000 investment in a machine that had an estimated useful life of five years and an estimated salvage value of $10,000. The machine was expected to increase net income (and cash flows) before depreciation expense by $15,000 per year. The criteria for approving a new investment are that it have a rate of return of 16% and a payback period of three years or less.
Calculate the accounting rate of return on this investment for the first year. Assume straight-line depreciation. (Round your answer to 1 decimal place. Omit the "%" sign in your response.)
Using Table 6-4, calculate the net present value of this investment using a cost of capital of 16%. (Round pv factor to 4 decimal places, intermediate calculations and final answer to the nearest dollar amount. Omit the "$" sign in your response.)
Busy Beaver Corp. is interested in reviewing its method of evaluating capital expenditure proposals using the accounting rate of return method. A recent proposal involved a $50,000 investment in a machine that had an estimated useful life of five years and an estimated salvage value of $10,000. The machine was expected to increase net income (and cash flows) before depreciation expense by $15,000 per year. The criteria for approving a new investment are that it have a rate of return of 16% and a payback period of three years or less.
Explanation / Answer
Requirement 1:
Requirement2:
Requirement 3:
Solution: - Computation of the following a. Accounting rate of return = Net Income/Average Investment Net Income before depreciation $ 15,000 Depreciation $8,000 Net Income $ 7,000 Average investment $ 46,000 Accounting rate of return 15.22% b. The investment would not be made as the rate of return at 15.2% is less than the required rate of return of 16%Requirement2:
a. Payback period is the time taken to recover the initial investment, based on cash flows Initial investment $50,000 Cash flow per year $ 15,000 Payback period = 50,000/15,000 = 3.33 years b. The investment would not be made as the payback period is greater than the cut off period of 3 yearsRelated Questions
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