Problem 24-6B (40 minutes)
Part 1: Payback period
Period Cash flow Cumulative cash flow
0……………………………………..….….….…….…….…….$(800,000) $(800,000)
1……………………………………..….….….…….…….…….450,000 (350,000)
The payback period is about 1.9 years.
Part 2: Break-even time
Period Cash Flow
Present Value
of 1 at 10%
Present Value
of Cash Flows
Cumulative
Present Value
of Cash Flows
0……………..… $(800,000) 1.0000 $(800,000) $(800,000)
1……………..… 450,000 0.9091 409,095 (390,905)
$60,345 / $262,955 = 0.2 (rounded)
Part 3: Net present value
From the chart in part 2, we can see that the net present value of the
investment is $407,510.
Part 4
If the company requires a payback period of 2 years for any project, this
Problem 24-6B (Concluded)
Part 5
While the total cash flows are identical to those in Problem 24-5B, the cash
flows are reversed, with the largest cash flows coming in the early years of
Financial and Managerial Accounting, 6th Edition
SERIAL PROBLEM — SP 24
Serial Problem, Business Solutions (50 minutes)
COMPUTING NET CASH FLOWS FROM NET INCOME
Net income Cash flows
Sales……………..………………………………………………..….…$375,000 $375,000
Materials, labor & overhead…………….…………….…….…(200,000) (200,000)
Depreciation*…………..………………………………….…….….. (50,000)
* Depreciation expense = $300,000 / 6 years = $50,000
** This equals the net income plus the depreciation expense ($61,250 + $50,000 = $111,250).
2. Accounting rate of return = = 40.8%
*Average investment
Cost……………..……..…........…......…....$300,000
Salvage……………………………………….. 0
Sum……………..…........................….....$300,000
Average (Sum/2)………....................…$150,000
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Solutions Manual, Chapter 24
$300,000
$111,250
$61,250
$150,000*
1427
Reporting in Action — BTN 24-1
1. The internal rate of return (given here as 10%) is the rate which yields a
net present value of zero for an investment. The annuity factor for 10
periods and a discount rate of 10% is 6.1446. This means we can solve
for the amount of annual cash flows as follows:
$2.12 billion = Annual cash flows x 6.1446
2. Answer depends on the information obtained.
Financial and Managerial Accounting, 6th Edition
Comparative Analysis — BTN 24-2
1. We know that the present value equals the annual cash flows times the
present value of an annuity factor for 7 periods, 15%. This means:
Therefore,
Annual cash flows = $2.42 billion / 4.1604
Annual cash flows = $581,674,839 per year (rounded)
2. Relatively speaking, Google’s assumed hurdle rate is higher than
Ethics Challenge — BTN 24-3
1. Present value of $100 to be received in 10 years assuming a 12%
discount rate is approximately $32. This is computed as $100 x 0.322.
2. We need to be concerned about any project with expected long-term
cash inflows. This is especially the case if the larger cash inflows are
Communicating in Practice — BTN 24-4
Instructor note: Answers will vary, but responses should address the questions
asked and include some discussion of the following points for each method.
Payback Period Accounting Rate
of Return
Net Present
Value
Internal Rate
of Return
Measurement
basis
Cash flows Accrual income Cash flows
Profitability
Cash flows
Profitability
Limitations Ignores time
value of money
Ignores cash
flows after
payback period
Ignores time
value of
money
Ignores annual
rates over life
of project
Difficult to
compare
dissimilar
projects
Ignores
varying
risk levels
over life of
project
Financial and Managerial Accounting, 6th Edition