Comments

  1. avatar says

    Sir,i am from Pakistan and i understand the method of taking Average Balance Sheet Value But i have one question that,can we use the other way for taking the Average Balance Sheet value, like this one;
    Add Year 1st+2nd+3rd+4th Balance Sheet Values And then Divide the Total with 4.(i have try this one and i got less then $45000)
    And if not then why not we can use this Method.
    ThankYou.

    • Avatar of johnmoffat says

      Suppose that this morning you had $100 and you were spending all day so at the end of the day (10 hours later) you had nothing left.

      What was the average amount of money in your pocket? Surely, on average you had $50 – you would not divide by 10 and say that it was $10.

      Same example, but this time you still had $20 left at the end of the day. In that case on average you would have had more money – (100 + 20) / 2 = on average $60.

      Hope that makes sense. If not then say and I will try and explain in another way :-)

  2. avatar says

    Hi John,

    the lecture shows that payback time is 2.75 years, it’s simply add first 2 years cash inflow and a proportion of 3rd year cash inflow. However you didn’t take present value of these inflows into account. Actual payback time should be longer than 3 years if we convert these inflows to present value.

    • Avatar of johnmoffat says

      But that is how we calculate the payback period – we do not discount the cash flows.

      If you are asked for the ‘discounted payback period’ then you do discount the flows (and the discounted payback period will indeed be longer than the normal payback period).

  3. avatar says

    Hi Sir
    When we are calculating Average Book Value of the Asset, aren’t we supposed to calculate per annum? I got a bit confused and I actually calculated the depreciation in linear method. However, why do we calculate ARR in that way?
    i.e. Average profit per annum from an investment/ Average Book Value of the Asset.

    I would appreciate it if you could explain this a bit :)

    Furthermore, I know this is nothing relating to PayBack Period. But don’t you think, the longer the Payback period, the lower the value of that money? As in the PV of the inflow decreses.

      • Avatar of johnmoffat says

        In real life you might be more interested in the ARR year by year. However normally in the exam we simply calculate the average. It does not matter whether we depreciate on a straight line basis or some other way – in total the depreciation will be the difference between the cost and the scrap value, which method of deprecation we use.

        With regard to the payback period, what you say about the present value may well be true. However, companies use a range of measures, and one big problem with NPV’s is that the further into the future we are estimating the cash flows, the more it becomes almost a guess. The shorter the payback period, the more certain we will be that we will really get the cash back.

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