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Able Ltd is considering a new project for which the following information is available:
Initial cost- $300,000
expected life-5 years
estimated scrap value-$20,000
additional revenue from the project $120,000 per year
incremental costs of the project-$30,000 per year
cost of capital- 10%Sir in this question, I’m only asking this out of curiosity because i re-watched your lecture on payback period but you didn’t show about scrap value, sir here our cash flows are 90,000 but I’m curious are we not going to add scrap value in that 90k
Also sir that initial investment, aren’t we going to deduct scrap value from that
280,000/110,000 to find payback?
And same for discounting are we going to include scrap value in that, please could you explain this
Also sir this thing is confusing me, that for discounting you said if cash flows are at the end we will consider it like if answer is 3.4 years aka it’s going to be 4 years, while for payback it would be 3 years, but when i actually selected 3 years for payback it got incorrect and selected it’d be within 4 years, i didn’t get that, and same for discounting it didn’t mention if cash flows are at the end so obviously we will select the near year, but even for that it got incorrect, please could you explain this
I really appreciate the time you take out to clear queries of every student out here, and till now you’ve helped me out with many questions, i just want to clear myself with every confusion i have, so i can do my best in exam, thankyou sir!
It seems again that you have not watched my lectures on this.
For the payback period the scrap value here is not relevant because they only get that at the end of the 5 years. The payback period is the number of years it takes to get back the original 300,000, which is 3.4 years. If the answer is required in years, then after 3 years they have not got back 300,000. It is within 4 years just as I explain in my lecture.
For discounted cash flows we look at all flows over the entire 5 years (which includes the scrap in 5 years time). Again I show this in my lectures.
And sir in discounted as we got just one cash flow each year 90,000 so we are going to discount it at annuity factor while for scrap we are going to use normal discount factor?
Also sir last thing you calculated accounting rate of return, using these values
Depreciation 300,000-20000/5=56,000
Deducting that from profit 90,000-56000=34,000 average profit after depreciation
But sir when we calculate average profit are we not going to divide it with number of years?
I got the average investment
First sentence: yes.
The cash flow each year is 90,000. The depreciation each year is 56,000. Therefore the profit each year is 34,000. Why on earth would we divide it by anything?
Oh yes sir mybad and one last thing sir for the first sentence after getting the value of scrap and cash flow discounted one, we are going to add it right? And then divide it from cash out flow which is $300,000 to get the discounted payback period
Your original question asked about discounted cash flow.
Now you are asking about the discounted payback period.
As I explain in my lectures, you discount each flow and then add each year until it comes to the total of the initial investment.
You do not divide anything by anything.
Please watch the lectures.
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