Investment Analysis: Payback Period and Accounting Rate of Return
What is the payback period for RP Investments Ltd's investment in new equipment?
How is the accounting rate of return calculated for the investment?
Payback Period Calculation:
The payback period for the investment is between 2 and 3 years, indicating when the initial investment will be recovered.
To calculate the payback period, we need to determine how long it takes for the cumulative cash flows to recover the initial investment of R550,000.
Year 1 cash flow: R220,000
Year 2 cash flow: R200,000
Year 3 cash flow: R120,000
Year 4 cash flow: R110,000
Year 5 cash flow: R50,000
Cumulative cash flows:
Year 1: R220,000
Year 2: R420,000 (R220,000 + R200,000)
Year 3: R540,000 (R420,000 + R120,000)
Year 4: R650,000 (R540,000 + R110,000)
Year 5: R700,000 (R650,000 + R50,000)
Payback Period and Accounting Rate of Return Analysis:
The payback period is the time it takes to reach or surpass the initial investment. In this case, the cumulative cash flows exceed R550,000 in Year 3, but they do not exceed R550,000 in Year 2. Therefore, the payback period is between 2 and 3 years.
To calculate the accounting rate of return, we need to determine the average annual profit and divide it by the average investment.
Average annual profit: (R220,000 + R200,000 + R120,000 + R110,000 + R50,000) / 5 = R140,000
Average investment: (R550,000 - R50,000) / 2 = R250,000
Accounting rate of return: (R140,000 / R250,000) * 100 = 56%
Therefore, the accounting rate of return is 56%.