PAYBACK, ACCOUNTING RATE OF RETURN
A hospital is considering the possibility of two new purchases: new X ray equipment and new biopsy equipment. Each project would require an investment of $750,000. The expected life for each is five years with no expected salvage value. The net cash inflows associated with the two independent projects are as follows:
|
Year |
X Ray Equipment |
Sonogram Equipment |
|
1 |
$375,000 |
$ 75,000 |
|
2 |
150,000 |
75,000 |
|
3 |
300,000 |
525,000 |
|
4 |
150,000 |
600,000 |
|
5 |
75,000 |
675,000 |
1. Compute the payback period for each project. Assume that the manager of the hospital accepts only projects with a payback period of three years or less. Offer some reasons why this may be a rational strategy even though the NPV computed may indicate otherwise.
2. Compute the accounting rate of return for each project using average investment.