Concept explainers
(a)
Introduction:
Payback period is the time period required to cover the cost of an investment or it is the duration of time needed to recover the initial cost of an investment.
To compute:
The payback period of the given investments and rank them in order of their payback period.
Answer to Problem 12E
Payback period (project X) = 1.6 years (Rank 1)
Payback period (Project Y) = 2 years (Rank 3)
Payback period (Project Z) = 1.9 years (Rank 2)
Explanation of Solution
To calculate the payback period:
Formula used:
(b)
Introduction:
To compute:
The net present value of the given investments and rank them in order of their Net present value.
Answer to Problem 12E
Net present value (Project X) = $5,000 (Rank 3)
Net present value (Project Y) = $13,000 (Rank 2)
Net present value (Project Z) = $20,000 (Rank 1)
Explanation of Solution
To calculate NPV:
Formula used:
Net present value = PV of cash inflows − Initial investment
Net present value (Project X) = $45,000 - $40,000
= $5,000
Net present value (Project Y) = $33,000 - $20,000
= $13,000
Net present value (Project Z) = $70,000 - $50,000
= $20,000
(c)
Introduction:
Profitability index is the ratio of the benefits of a project to its costs. There is a directly proportional relationship between profitability index and the attractiveness of a project.
To compute:
The Profitability index of the given investments and rank them in order of their Net present value.
Answer to Problem 12E
Profitability Index
- Project X = 1.12 (Rank 3)
- Project Y = 1.65 (Rank 1)
- Project Z = 1.40 (Rank 2)
Explanation of Solution
Formula used to calculate profitability index:
Projects | Profitability index |
Project X | |
Project Y | |
Project Z |
(d)
Introduction:
Profitability index is the ratio of the benefits of a project to its costs. There is a directly proportional relationship between profitability index and the attractiveness of a project.
To state:
In case of limited availability of funds, which investment should be opted by the manager.
Answer to Problem 12E
As per the profitability index, investment in project Y should be opted by the manager.
Explanation of Solution
In case of limited availability of funds, it will be better for the company to prioritize the projects depending upon their profitability index. The profitability index will make the comparison a lot easier as it is expressed as a ratio and not as the dollar value.
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Chapter 11 Solutions
Managerial Accounting
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