payback+and+arr

  =Accounts and finance=  Why not have a go at the following examples to see how well you have understood the calculation of payback and ARR? A firm has to choose between two possible projects and the details of each project are as follows: ||~ Capital cost ||~ $000 ||
 * == [|Table of Contents]  ==
 * 1)  [|Topic pack - Accounts and finance - introduction]
 * 2)  [|3.1 Sources of finance - notes]
 * 3)  [|3.1 Sources of finance - questions]
 * 4)  [|3.2 Investment appraisal - notes]
 * 5)  [|Investment appraisal]
 * 6)  [|3.2 Investment appraisal - questions]
 * 7) Payback & ARR - self-test questions
 * 8)  [|Discounted cash flow - self-test questions]
 * 9)  [|Inv. appraisal techniques - short answer questions]
 * 10)  [|Quantitative factors - numerical questions (1)]
 * 11)  [|Quantitative factors - numerical questions (2)]
 * 12)  [|Investment appraisal - quantitative factors - numerical questions 2]
 * 1)  [|3.3 Working capital - notes]
 * 2)  [|3.3 Working capital - questions]
 * 3)  [|3.4 Budgeting - notes (HL only)]
 * 4)  [|3.4 Budgeting - questions]
 * 5)  [|3.5 Final accounts - notes]
 * 6)  [|3.5 Final accounts - questions]
 * 7)  [|3.5 Final accounts - simulations and activities]
 * 8)  [|3.6 Ratio analysis - notes]
 * 9)  [|3.6 Ratio analysis - questions]
 * 10)  [|3.6 Ratio analysis - simulations and activities]
 * 11)  Printable version  ||  ==Payback & ARR - self-test questions ==
 * ~ Project A || 300 ||
 * ~ Project B || 500 ||
 * ~ Project C || 450 ||


 * ~ <span style="background-color: rgba(255,255,255,0);">Net cash inflow ($000) ||~  ||~   ||~   ||
 * ~  ||~ <span style="background-color: rgba(255,255,255,0);">Project A ||~ <span style="background-color: rgba(255,255,255,0);">Project B ||~ <span style="background-color: rgba(255,255,255,0);">Project C ||
 * ~ <span style="background-color: rgba(255,255,255,0);">Year 1 || <span style="background-color: rgba(255,255,255,0);">75 || <span style="background-color: rgba(255,255,255,0);">100 || <span style="background-color: rgba(255,255,255,0);">50 ||
 * ~ <span style="background-color: rgba(255,255,255,0);">Year 2 || <span style="background-color: rgba(255,255,255,0);">125 || <span style="background-color: rgba(255,255,255,0);">200 || <span style="background-color: rgba(255,255,255,0);">75 ||
 * ~ <span style="background-color: rgba(255,255,255,0);">Year 3 || <span style="background-color: rgba(255,255,255,0);">125 || <span style="background-color: rgba(255,255,255,0);">300 || <span style="background-color: rgba(255,255,255,0);">250 ||
 * ~ <span style="background-color: rgba(255,255,255,0);">Year 4 || <span style="background-color: rgba(255,255,255,0);">100 || <span style="background-color: rgba(255,255,255,0);">300 || <span style="background-color: rgba(255,255,255,0);">300 ||
 * ~ <span style="background-color: rgba(255,255,255,0);">Year 5 || <span style="background-color: rgba(255,255,255,0);">75 || <span style="background-color: rgba(255,255,255,0);">150 || <span style="background-color: rgba(255,255,255,0);">200 ||

<span style="background-color: rgba(255,255,255,0);">What is the payback period of project A? <span style="background-color: rgba(255,255,255,0);">You answered: 3
 * <span style="background-color: rgba(255,255,255,0);">1 || =====<span style="background-color: rgba(255,255,255,0);">Payback period - Project A =====

<span style="background-color: rgba(255,255,255,0);">The correct answer is: 2.8 years or 2 years 10 months

<span style="background-color: rgba(255,255,255,0);">After 2 years, the project has earned $200k leaving $100k to get to payback.The net cash flow in year 3 is $125 and so 100/125 gives 0.8 of a year or 9.6 months. We can round this up to 10 months, so overall the project pays back in 2 years and 10 months. ||

<span style="background-color: rgba(255,255,255,0);">What is the payback period of project B? <span style="background-color: rgba(255,255,255,0);">You answered: 2.6
 * <span style="background-color: rgba(255,255,255,0);">2 || =====<span style="background-color: rgba(255,255,255,0);">Payback period - Project B =====

<span style="background-color: rgba(255,255,255,0);">The correct answer is: 2.67 years or 2 years 8 months

<span style="background-color: rgba(255,255,255,0);">After 2 years, the project has earned $300k leaving $200k to get to payback.The net cash flow in year 3 is $300 and so 200/300 gives 0.67 of a year or 8 months, so overall the project pays back in 2 years and 8 months. ||

<span style="background-color: rgba(255,255,255,0);">What is the payback period of project C? <span style="background-color: rgba(255,255,255,0);">You answered: 3.25
 * <span style="background-color: rgba(255,255,255,0);">3 || =====<span style="background-color: rgba(255,255,255,0);">Payback period - Project C =====

<span style="background-color: rgba(255,255,255,0);">The correct answer is: 3.25 years or 3 years 3 months

<span style="background-color: rgba(255,255,255,0);">After 3 years, the project has earned $375k leaving $75k to get to payback.The net cash flow in year 4 is $300 and so 75/300 gives 0.25 of a year or 3 months, so overall the project pays back in 3 years and 3 months. ||

<span style="background-color: rgba(255,255,255,0);">What is the average rate of return (ARR) of project A? <span style="background-color: rgba(255,255,255,0);">You answered: 0.667
 * <span style="background-color: rgba(255,255,255,0);">4 || =====<span style="background-color: rgba(255,255,255,0);">ARR - Project A =====

<span style="background-color: rgba(255,255,255,0);">The correct answer is: 13.33%

<span style="background-color: rgba(255,255,255,0);">After 5 years, the project has earned a total cash flow of $500k. The capital cost is $300k and so the total gain is $200k.If we divide the total gain by 5 (number of years) we get an average return of $40k.The average annual return of $40k as a percentage of the original capital cost (40/300 * 100) is 13.33%. ||

<span style="background-color: rgba(255,255,255,0);">What is the average rate of return (ARR) of project B? <span style="background-color: rgba(255,255,255,0);">You answered: 0.22
 * <span style="background-color: rgba(255,255,255,0);">5 || =====<span style="background-color: rgba(255,255,255,0);">ARR - Project B =====

<span style="background-color: rgba(255,255,255,0);">The correct answer is: 22%

<span style="background-color: rgba(255,255,255,0);">After 5 years, the project has earned a total cash flow of $1050k. The capital cost is $500k and so the total gain is $550k.If we divide the total gain by 5 (number of years) we get an average return of $110k.The average annual return of $110k as a percentage of the original capital cost (110/500 * 100) is 22%. ||

<span style="background-color: rgba(255,255,255,0);">What is the average rate of return (ARR) of project C? <span style="background-color: rgba(255,255,255,0);">You answered: 0.189
 * <span style="background-color: rgba(255,255,255,0);">6 || =====<span style="background-color: rgba(255,255,255,0);">ARR - Project C =====

<span style="background-color: rgba(255,255,255,0);">The correct answer is: 18.9%

<span style="background-color: rgba(255,255,255,0);">After 5 years, the project has earned a total cash flow of $875k. The capital cost is $450k and so the total gain is $425k.If we divide the total gain by 5 (number of years) we get an average return of $85k.The average annual return of $85k as a percentage of the original capital cost (85/450 * 100) is 18.9%. ||

<span style="background-color: rgba(255,255,255,0);">Which project would you recommend to the board to accept and why? <span style="background-color: rgba(255,255,255,0);"> <span style="background-color: rgba(255,255,255,0);">The best project on these criteria appears to be project B. It has the lowest payback period (just) of 2 years and 8 months and also has the best ARR figure at 22%. || <span style="background-color: rgba(255,255,255,0);"> <span style="background-color: rgba(255,255,255,0);">Copyright - Triple A Learning
 * <span style="background-color: rgba(255,255,255,0);">7 || =====<span style="background-color: rgba(255,255,255,0);">Which project? =====