Fundamental Managerial Accounting Concepts
Fundamental Managerial Accounting Concepts
8th Edition
ISBN: 9781259569197
Author: Thomas P Edmonds, Christopher Edmonds, Bor-Yi Tsay, Philip R Olds
Publisher: McGraw-Hill Education
bartleby

Videos

Question
Book Icon
Chapter 10, Problem 20PSA

a.

To determine

Ascertain the payback period and unadjusted rate of return (use average investment) for each alternative.

a.

Expert Solution
Check Mark

Explanation of Solution

The annual rate of return method:

The annual rate of return is the amount of income which is earned over the life of the investment. It is used to measure the annual income as a percent of the annual investment of the business, and it is also known as the accounting rate of return.

Payback period:

Payback period is the expected time period which is required to recover the cost of investment. It is one of the capital investment method used by the management to evaluate the proposal of long-term investment (fixed assets) of the business.

Ascertain the payback period for each alternative as follows:

Alternative 1:

Payback period for alternative 1}=Cost of investmentCash flows per year (1)=$16,200$9,560=1.69 years

Alternative 2:

Payback period for alternative 2}=Cost of investmentCash flows per year (1)=$20,160$10,720=1.88 years

Ascertain the unadjusted rate of return for each alternative as follows:

Alternative 1:

Unadjusted rate of return = Average increase in net income(Net cost of original investment2)=$4,160($16,2002)×100=$4,160$8,100×100=51.36%

Alternative 2:

Unadjusted rate of return = Average increase in net income(Net cost of original investment2)=$5,680($20,1602)×100=$5,680$10,080×100=56.35%

Working note:

Calculate the amount of cash flow per year for both alternatives:

ParticularsAlternative 1Alternative 2
Cash revenue$12,400$17,000
Less: Operating expense1,8004,860
Depreciation expense5,400(4)5,040(5)
Income before tax5,2007,100
Income tax expense1,040 (2)1,420 (3)
Net Income4,1605,680
Add: Depreciation  expense5,4005,040
Cash flow per year$9,560$10,720

Table (1)

(1)

Calculate the amount of income tax expense for alternative 1:

Income tax expensefor alternative 1}=Rate of tax×Income before tax=20100×$5,200=$1,040

(2)

Calculate the amount of income tax expense for alternative 2:

Income tax expensefor alternative 2}=Rate of tax×Income before tax=20100×$7,100=$1,420

(3)

Calculate the amount of depreciation expense for alternative 1:

Depreciation expensefor alternative 1}=Acquisition cost – Salvage valueUseful life=$16,20003 Years=$5,400

(4)

Calculate the amount of depreciation expense for alternative 2:

Depreciation expensefor alternative 2}=Acquisition cost – Salvage valueUseful life=$20,16004 Years=$5,040

(5)

b.

To determine

Indicate the investment alternative that is recommendable and explain the reason behind it.

b.

Expert Solution
Check Mark

Explanation of Solution

Indicate the investment alternative that is recommendable and explain the reason behind it as follows:

From the above calculation it is clear that alternative 2 appears better than alternative 1. This is because alternative 2 has a longer useful life and higher unadjusted rate of return, while alternative 1 has a shorter useful life and shorter unadjusted rate of return.

If the investor prefers shorter payback period then the investor can go for alternative 1 since it provide a quicker payback than alternative 2.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Chapter 10 Solutions

Fundamental Managerial Accounting Concepts

Knowledge Booster
Background pattern image
Accounting
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.
Recommended textbooks for you
Text book image
FINANCIAL ACCOUNTING
Accounting
ISBN:9781259964947
Author:Libby
Publisher:MCG
Text book image
Accounting
Accounting
ISBN:9781337272094
Author:WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:Cengage Learning,
Text book image
Accounting Information Systems
Accounting
ISBN:9781337619202
Author:Hall, James A.
Publisher:Cengage Learning,
Text book image
Horngren's Cost Accounting: A Managerial Emphasis...
Accounting
ISBN:9780134475585
Author:Srikant M. Datar, Madhav V. Rajan
Publisher:PEARSON
Text book image
Intermediate Accounting
Accounting
ISBN:9781259722660
Author:J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher:McGraw-Hill Education
Text book image
Financial and Managerial Accounting
Accounting
ISBN:9781259726705
Author:John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting Principles
Publisher:McGraw-Hill Education
Relevant Costing Explained; Author: Kaplan UK;https://www.youtube.com/watch?v=hnsh3hlJAkI;License: Standard Youtube License