[Janakie]

Baba Company is considering buying a cutting equipment that cost RM18,000. The equipment
will be used in its operation for the next four years and will be depreciated using straight line
method. The following data are given pertaining the investment proposal:
Working capital 5,000
Operations (per year for 4
years):
Cash receipts RM20,000
Cash expenditures 12,000
Disinvestment:
Salvage value of
equipment
RM2,000
Recovery of working
capital
5,000
Discount rate 10 percent
The discount factors are given below:
Period Present Value
Factor
1 0.909
2 0.826
3 0.751
4 0.683
Required:
Determine the following values:
a) Payback period

b) Accounting rate of return on average investment

c) Net present value

[rehmanvohra]

We will not solve the problem for you, but we can guide you as to how to go about it.

The question requires three items:
1. Payback period
2. Accounting rate of return
3. Net Present Value

1. Payback period. I would calculate simple payback period and not the discounted payback period. A;; you need to do is prepare a table as follows:

Year Cash flow Balance

Starting with year 0 when there is an outflow, enter the net cash inflows in each of the succeeding years. For each year calculate the balance after each entry. In the initial years there will be negative balances and in one of the succeeding years there will be a positive balance. Now take the negative balance of the immediate previous year and compare it with the net cash flow of the next year. This will give you a fraction which is the fraction of a year when the negative balance will be recovered which when added to the years of negative balance will give you the total payback period.

2. Accounting rate of return is calculated by dividing the average net profits by the average investment.

3. Net Present Value

You need to prepare a table as follows:

Year Cash Flow Discount rate Present Value

Starting with year 0 enter the cash flows multiply the amount by the discount rate which gives present value.
Add up the present value column and you get the net present value. This may be positive or negative. But that is not the problem right now.
Try it out and if you need I can help you with any problem based on your answer.