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Chapter 26: Q8RQ (page 1463)

How is payback calculated with equal net cash inflows?

Short Answer

Expert verified

Answer

The payback period calculates by dividing by keeping the original investment amount in the numerator and the annual cash flow in the denominator.

Step by step solution

01

Meaning of Payback Period

The payback period is the time it takes for an exchange to recover its original investment. The project with the shortest payback period is the most appealing.

02

Calculation of payback with equal net cash inflows

The payback period (in years) of an investment is computed utilizing the taking after the equationif cash inflows are equal:

Payback=AmountlnvestedYearlyNetCashInflowExpected

The fund managers use the payback time period to evaluate whether or not to continue with an investment. One drawback of the payback period is that it does not account for the time worth of money.

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Most popular questions from this chapter

What is the decision rule for NPV?

Calculate the present value of the following future cash flows, rounding all calculations to the nearest dollar.

11. \(5,000 received in three years with interest of 10%

12. \)5,000 received in each of the following three years with interest of 10%

13. Payments of \(2,000, \)3,000, and $4,000 received in years 1, 2, and 3, respectively, with interest of 7%

Question: Using the payback and accounting rate of return methods to make capital investment decisions

Consider how Hunter Valley Snow Park Lodge could use capital budgeting to decide whether the \(11,000,000 Snow Park Lodge expansion would be a good investment. Assume Hunter Valley鈥檚 managers developed the following estimates concerning the expansion:

Number of additional skiers per day 121 skiers

Average number of days per year that weather conditions

allow skiing at Hunter Valley 142 days

Useful life of expansion (in years) 7 years

Average cash spent by each skier per day \) 241

Average variable cost of serving each skier per day 83

Cost of expansion 11,000,000

Discount rate 10%

Assume that Hunter Valley uses the straight-line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its seven-year life.

Requirements

  1. Compute the average annual net cash inflow from the expansion.
  2. Compute the average annual operating income from the expansion.

How is payback calculated with unequal net cash inflows?

David is entering high school and is determined to save money for college. David feels he can save $6,000 each year for the next four years from his part-time job. If David is able to invest at 7%, how much will he have when he starts college?
See all solutions

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