1.
Calculate the payback period for the given proposal.
1.
Explanation of Solution
Payback period: 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 proposal of long-term investment (fixed assets) of the business. But payback method has high risk than other method, because it does not follow the time value of money concept in valuing the cash inflows.
Calculate the payback period for the given proposal as follows:
Initial investment after tax = $120,000.
| Year | Incremental | Accumulated cash flow |
| 1 | $ 40,000 | $40,000 |
| 2 | $40,000 |
$80,000 |
| 3 | $40,000 |
$120,000 |
| 4 | $38,000 |
$158,000 |
| 5 | $37,000 |
$195,000 |
Table (1)
Therefore, the payback period for the given proposal is 3 years.
2.
Calculate the accounting
2.
Explanation of Solution
Accounting rate of return method: Accounting 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 average rate of return.
Calculate the accounting rate of return for the given proposal using initial investment as follows:
Working note (1):
Calculate the average incremental revenue.
Working note (2):
Calculate the average incremental expense.
Working note (3):
Calculate the average
3.
Calculate the accounting rate of return for the given proposal using average investment.
3.
Explanation of Solution
Calculate the accounting rate of return for the given proposal using average investment as follows:
Working note (4):
Calculate the average investment.
4.
Explain the reason why the discounted cash flow methods are superior to the payback and accounting rate of return.
4.
Explanation of Solution
Explain the reason why the discounted cash flow methods are superior to the payback and accounting rate of return as follows:
Discounted cash flow method reflects time value of money, and payback and accounting rate of return does not use the present value concept in valuing cash flows occurring in the different time period. Hence, the
5.
Explain whether the activity of board’s chairperson is ethical or not.
5.
Explanation of Solution
No, the activity of board’s chairperson is not ethical because chairperson should provide fair and objective information about the project and management should evaluate and choose the best alternative based on the high return.
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Chapter 16 Solutions
Managerial Accounting: Creating Value in a Dynamic Business Environment
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