Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 43

Interpretation of present value analysis and payback The Goodwrench Garage is considering an investment in a new tune-up computer. The cost of the computer is $48,000. A cost analyst has calculated the discounted present value of the expected cash flows from the computer to be $52,650, based on the firm’s cost of capital of 12%.

Required:

a. What is the expected return on investment of the machine, relative to 12%? Explain your answer.

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b. The payback period of the investment in the machine is expected to be 4.25 years. How much weight should this measurement carry in the decision about whether or not to invest in the machine? Explain your answer.

Step 1 of 3

Present value analysis: It is a technique of evaluating the value of money currently with the value of money in a specified future date.

Net present value (NPV): NPV is the distinction of present value between the cash inflows and cash outflows.

Payback period: The duration of time essential to recover the investment cost of a specified portfolio.