(Interpreting ARR, Payback, and NPV) The Board of Grudgework Holdings has received a presentation supporting a $600,000 capital investment. The calculations for accounting rate of return, payback, and discounted cash flows are shown below.
|
Accounting Rate of Return |
Year 0 |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
Initial investment |
$600,000 |
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|
Depreciation @ 20% |
$120,000 |
$120,000 |
$120,000 |
$120,000 |
$120,000 |
|
|
Book value at year-end |
480,000 |
360,000 |
240,000 |
120,000 |
0 |
|
|
Cash flows |
150,000 |
250,000 |
200,000 |
150,000 |
100,000 |
|
|
Profit |
30,000 |
130,000 |
80,000 |
30,000 |
(20,000) |
|
|
ARR |
6.3% |
36.1% |
33.3% |
25.0% |
||
|
Average profits |
$ 50,000 |
|||||
|
Average investment |
300,000 |
|||||
|
Average ARR |
16.7% |
|
Payback |
Year 0 |
Year! |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
Initial investment |
$(600,000) |
|||||
|
Cash flows |
$150,000 |
$250,000 |
$200,000 |
$150,000 |
$100,000 |
|
|
Cumulative cash flow |
150,000 |
400,000 |
600,000 |
|||
|
Payback |
= 3 years |
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|
Net Present Value |
Year 0 |
Year! |
Year 2 |
Year 3 |
Year 4 |
Years |
|
Cash flows |
$(600,000) |
$150,000 |
$250,000 |
$200,000 $150,000 $100,000 |
|
|
Net present value @ 8% |
$90,303 |
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What issues would you draw to the attention of the board in considering these figures?