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Problem 13-19 (continued)
3. The formula for the payback period is:
Investment required
Payback period = Annual net cash inflow
$270,000
= = 4.5 years
$60,000*
Problem 13-20 (continued)
3. The dollar value per year that would be required for the intangible
benefits is:
Negative net present value to be offset $49,450
Problem 13-21 (continued)
3. Which ranking is best will depend on Revco Products’ opportunities for
reinvesting funds as they are released from the project. The internal
rate of return method assumes that any released funds are reinvested at
the internal rate of return. This means that funds released from project
Problem 13-23 (45 minutes)
1. The payback periods for Products A and B are calculated using a two-
step process. First, the annual net cash inflows are calculated as
follows:
Product A
Product B
Sales revenues .....................................
$250,000
$350,000
Variable expenses ................................
(120,000)
(170,000)
Fixed out-of-pocket operating costs ......
(70,000)
(50,000)
Annual net cash inflows ........................
$ 60,000
$130,000
The second step is to compute each product’s payback period as
follows:
Product A
Product B
Investment required (a) ........................
$170,000
$380,000
Annual net cash inflow (b) ....................
$60,000
$130,000
Payback period (a) ÷ (b) ......................
2.83 years
2.92 years
Problem 13-23 (continued)
3. The internal rate of return for each product is calculated as follows:
Product A
Product B
Investment required (a) ................................
$170,000
$380,000
Annual net cash inflow (b) .............................
$60,000
$130,000
Factor of the internal rate of return (a) ÷ (b) ..
2.833
2.923
Looking in Exhibit 13B-2 and scanning along the 5-period line, a factor of
2.833 falls right between 22% and 23%, so we’ll estimate an internal rate
of return for Product A of 22.5%. A factor of 2.923 is closest to 21%, so
we’ll estimate an internal rate of return for Product B of 21%.
4. The project profitability index for each product is computed as follows:
Product A
Product B
Net present value (a) ....................................
$26,440
$45,620
Investment required (b) ................................
$170,000
$380,000
Project profitability index (a) ÷ (b) .................
0.16
0.12
5. The simple rate of return for each product is computed as follows:
Product A
Product B
Annual net cash inflow ..................................
$60,000
$130,000
Depreciation expense ....................................
34,000
76,000
Annual incremental net operating income .......
$26,000
$54,000
Product A
Product B
Annual incremental net operating income (a)..
$26,000
$54,000
Initial investment (b) .....................................
$170,000
$380,000
Simple rate of return (a) ÷ (b) .......................
15.3%
14.2%
6. The net present value calculations suggest that Product B is preferable
to Product A. However, the project profitability index reveals that
