# Investment appraisal part b, Payback period

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in this chapter we can understand the time value of money, the payback period and the internal rate of return and thank you so much of the lecturer in this chapter F2.

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hai john im syahirah from malaysia .My questions is about the high low method .
last few day before enter into my exam , when i’m doing my revision , there has a question that confusing me .

says : total cost : \$135,000 \$ 170,000
Activity level : 16,000 22,000
Variable costs p/u is constant within this range of activity but there is a step up of \$5,000 in the total fixed cost when the activity level exceeds 17500 units .

Q:what is the total cost at an activity level of 20,000 units ?

my calculation is i will :\$170k – \$5k -\$135k = \$30k
: 22k units – 16k units = 6k
Variable cost : \$5 p/u
Fixed cost : \$165k – (\$5k x 16k)
= \$85,000
thus : y = a + bx \$85,000 + (20k x \$5 ) = \$185,000
but my answer is wrong and the correct answer was \$160,000 .

can you please explain to me further why my calculation on fixed cost wrong ?
actually ,which cost that i should take either after minus up the step-up cost of \$5,000 (\$165,000) or including the step-up cost (\$170,000) ?

thanks sir . =)

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You calculation of the fixed cost is wrong. It should be 135000 – (16000 x 5) = 55000

Having got the variable cost as \$5, the quickest way to get the answer is just to say that the only difference between the total cost at 22000 and at 20000 is the variable cost if the extra 2000 units.

So the total cost will be 170000 – (2000 x 5)

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hi ,

if question asked : The company is aware that fixed costs INCREASE by \$500 when sales exceed 200 units.
Why the answers no needs to add back \$500 in the fixed costs ?

Your quickest way to use whether use for the questions when asked step up costs only and needs to add back that set up costs in the fixed costs ?

And the quickest way only use have step up costs ? thanks

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In case the initial cash outflow is not recovered over the life of the project which has some scrap value, then should we consider the cash inflow from scrap in our calculation for payback period

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Hello John, i have a question after watching this lecture and practicing i was doing the test given in the notes on page 119 the question 2 requires IRR which can be calculated only if there are two percentages given, in the answers given at the end it says you did it with 20% where did u get that 20% please help ……

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ohh ok should it be higher than the rate given ?

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If the rate given gives a positive NPV then your guess should be a higher rate. If it gives a negative NPV then your guess should be a lower rate.

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Ok thank u i did not knew that that is very helpful information =)

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our present value is 100000 so why do we need to find the present value of each and every year

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The present value is not 100,000!
100,000 is the initial cost of the project.

We calculate the present value of each year so that we can calculate how many years it takes to get back 100,000 (for the discounted payback period).

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I cant get the question 2 in test for this chapter, please help. How i supposed to know what percentage i need to work out to compare it with 12% and NPV 33830.

Also Im getting 3.34 in question 4 which is C and not D as its on the back.

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You can use any percentage as the second guess. The IRR will be slightly different because the relationship is not linear, but it will be the same to the nearest %.

The answer to question 4 is D. ‘Within’ means less than. 3.34 is not less than 3 years.

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I understand now for question 4 but then for question 3 should it be answer D as well?

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No.
By the end of three years, the total cash received is 330,000.
The payback period is the time to get back the initial investment of 270,000 and so this is going to be less that (or within) 3 years.

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From the discount tables. It is the one year discount factor at 10%.
(Have you watched the previous lecture on investment appraisal – part A ?)