Mastery Problem: Cash Payback and Average Rate of Return (Advanced) Companies use capital investment analysis to evaluate long-term investments. Capital investment evaluation methods that do not use present values are (1) Average rate of return method and (2) Cash payback method. Methods that do not use present value One category of capital investment evaluation methods does not use present value. The primary difference between the category of methods that do use present value and this category is that this category does not take the time value of money into account. The basic premise of the time value of money is that a dollar today is worth more than a dollar tomorrow True or False: Considering the fact that most firms use methods from each category, it can be concluded that both categories have value. True Feedback Cash Payback Method . The particulars of the method vary depending This method identifies how long it will take (in years) to recover the initial investment on whether the cash flows from an investment are even or uneven. Cash Payback Method (Even cash flows) Suppose that a particular investment required an up-front capital outlay of $100,000. This investment is expected to yield cash flows of $50,000 per year for 10 years. What is the payback period for this investment? If required, round your answer to two decimal places. Cash Payback Period - $ - years Check My Work 1. For years in which the annual cash flow exceeds the unrecovered investment, this is the unrecovered investment divided by the annual cash flow for that year. If Then Unrecovered Investment Annual Cash Flow Time Needed for Payback Unrecovered Investment Unrecovered Investment Annual Cash Flow Time Needed for Payback Annual Cash Flow for the Year Compute the time needed for payback for the following example assuming the investment required an up-front capital outlay of $100,000 and the uneven annual cash flows for each year are provided in the table. If an amount is zero, enter "O". For the time needed for payback, enter your answer to one decimal place, if less than one year (i.e. 0.2, 0.5, etc.), Year Annual Cash Flow Time Needed for Payback Unrecovered Investment (Beginning of year) $100,000 1 year $20,000 30,000 40,000 50,000 60,000 Total time needed for payback (to the nearest tenth of a year) - years Check My Work Average Rate of Return The average rate of return is another method that does not use present value and is commonly used in making capital investment decisions Unlike the cash payback method, the average rate of return focuses on income rather than cash flow. Assume that the investment involves an initial outlay of $100,000 with a five-year useful life and no salvage value under straight-line depreciation. The revenues are as follows: Year 1 - $20,000, Year 2 - $30,000, Year 3 - $40,000, Year 4 - $50,000 and Year 5 - $60,000. Use the minus sign to indicate a net loss. If an amount is zero, enter "O". Year Revenues Expenses Net Income Year 1 Net Income (loss) Year 2 Net Income (loss) Year 3 Net Income (loss) Year 4 Net Income (loss) Year 5 Net Income (loss) Total Net Income (five years) - $ Average Net Income Average Rate of Return Check My Work Previous Next >