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GVen
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| Posted: 31 Aug 2012 at 12:40 | IP Logged
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Wouldn't you expect that the solution below would factor in the year 4 salvage value into the net cash flow? Did they ignore the SV b/c they did not actually say when the asset life is, nor whether year 4 did or did not have the salvage value? Or perhaps are they assuming that, since we did not reach the end of year 4, there is no CF to be included?
Question CPA-05833
A company purchases an item for $43,000. The salvage value of the item is $3,000. The cost of capital is 8%.
Pertinent information related to this purchase is as follows:
Net cash flows Present value factor at 8%
Year 1 $10,000 0.926
Year 2 15,000 0.857
Year 3 20,000 0.794
Year 4 27,000 0.735
What is the discounted payback period in years?
a. 3.10
b. 3.25
c. 2.90
d. 3.14
Explanation
Choice "b" is correct. The discounted payback period of 3.25 years is computed as follows:
Net Present value
cash flows factor at 8% Product Cumulative
Year 1 $10,000 x 0.926 = 9,260 9,260
Year 2 15,000 x 0.857 = 12,855 22,115
Year 3 20,000 x 0.794 = 15,880 37,955
Year 4 27,000 x 0.735 = 19,845
The cumulative payback after three years is $37,955. The portion of the fourth year needed to fully pay back the
investment is computed as the ratio of the amount remaining to be recovered to the amount collected in the fourth
year as follows:
(43,000 - 37,955)
÷
19,845 = .252
The discounted payback period is, therefore:
Years 1-3 3.00 years
Year 4 .25 years
Total 3.25 years
Choice "a" is incorrect. This solution only anticipates payback of the capital investment net of salvage.
Choice "c" is incorrect. This solution does not apply the discount factors
Choice "d" is incorrect, per the above.
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Mark7
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| Posted: 05 Sep 2012 at 02:10 | IP Logged
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What is the discounted payback period IN YEARS
Think of it this way
Jan 1 2001 to Dec 31 2001 = 1 year
Jan 1 2002 to Dec 31 2002 = 2 years
Jan 1 2002 to Dec 31 2003 = 3 years
Years 1,2,3 = 37,922
OK, so far you are short about $5,045
In the forth year CF = 19,845/12 (months) = 1,654 per month, or
about 55 per day - In estimating about 91 days will get you there.
So...... $5,045/$19,845 = .2542
Check you answer to the estimate .2542 x 360 = 91.5 days
Normally B/E is easy - but using a 'dot' rather than months gets a
little tricky.
This Q ask for years -
not which year.
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GVen
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| Posted: 05 Sep 2012 at 10:11 | IP Logged
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understood except for the salvage value. i think my problem was assuming the yr 4 was also the end of life ans thus the time when the sv would flow but this was really just extraneous info. thanks, gv
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Mark7
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| Posted: 05 Sep 2012 at 15:49 | IP Logged
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GVen wrote:
understood except for the salvage value. i think
my problem was assuming the yr 4 was also the end of life ans
thus the time when the sv would flow but this was really just
extraneous info. thanks, gv |
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Yeah, that is a tricky Q. I suppose, for example if they sold the
item in year 3 or 4 then the salvage value would count toward the
cash flow and be used in the NPV (I really don't know, took BEC a
long time ago)
What is maddening about the Q is the use of decimals, instead of
days or months - Jeeze.... Come on, who the heck knows (off the
top of your head) that .254 is about 90 or 3 months. Unless you
think about it.
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raguse8706
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| Posted: 10 Sep 2012 at 16:30 | IP Logged
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It is a rule that salvage value is not taken into account when calculating the payback period. Payback period is only about the number of years it will take to recover the initial investment.
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Topic: cpa-05833 Payback Period
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