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Subject Topic: cpa-05833 Payback Period (Topic Closed Topic Closed) Post ReplyPost New Topic
  
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GVen
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Posted: 31 Aug 2012 at 12:40 | IP Logged  

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  

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  

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  

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

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  

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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