# The payback model measures how quickly managers

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investment in a long-term asset. The payback model measures how quickly managers expect to recover their investment dollars. The shorter the payback period, the more attractive the asset, all else being equal. Compute the payback period. (Round your answer to one decimal place.) Initial investment / Expected annual net cash inflow = Payback period \$2,050,000 / \$515,000 = 4.0 years One measure of profitability is the accounting rate of return (ARR) on an asset or other investment. The accounting rate of return measures the average rate of return over the asset's entire life. It focuses on the operating income an asset can earn. Before we can compute the accounting rate of return, we will first need to calculate the annual operating income from the asset. In order to determine the annual operating income, we will need to determine the annual depreciation. Use the table below to determine the annual operating income from the investment. Average annual Annual depreciation Average annual operating net cash inflow - expense = income from asset \$515,000 - \$256,250 = \$258,750 Now we can compute the accounting rate of return. (Round the percentage to the nearest tenth percent.) Average annual operating Accounting rate income from asset / Initial investment = of return \$258,750 / \$2,050,000 = 12.6 % The NPV (net present value) is the difference between the present value of the investment's net cash inflows and the investment's initial cost. We discount the net cash inflows to their present value, using a minimum desired rate of return. This rate is called the discount rate because it is the interest rate used for the present value calculations. It's also called the required rate of return or hurdle rate because the investment must meet or exceed this rate to be acceptable. The discount rate depends primarily on the

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riskiness of investments. The higher the risk, the higher the discount rate. A positive NPV means that the project earns more than the required rate of return. Compute the present value of the annuity, then reduce the present value by the initial cost of the investment to determine the net present value. (Round your answers to the nearest whole dollar.) NPV Calculation for Equal Annuity PV Factor Net Present Annual Net Cash Inflows (i=12%) Cash Inflow Value Present value of annuity, n=8 4.968 x \$515,000 = \$2,558,520 Less: Initial investment 2,050,000 Net present value (NPV) \$508,520 Optional: Click here to view the steps to solve for the net present value using a programmable calculator. LOADING... Optional: Click here to view the steps to solve for the net present value using Microsoft Excel (2007, 2010, and 2013). LOADING... The internal rate of return (IRR) is the rate of return, based on discounted cash flows, that a company can expect to earn by investing in the project. It is the interest rate that makes the NPV of the investment equal to zero. When we have even cash flows, we can determine the present value of the annuity factor.
• Fall '09
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