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Horngren'S Financial And Managerial Accounting
Found in: Page 1463

Short Answer

How is payback calculated with unequal net cash inflows?

Answer

Payback Period = Initial Investment / Net Cash Flow per period

See the step by step solution

Step by Step Solution

Step 1: Meaning of Payback Period

The payback period is the time it takes to recover the initial expense. It is the sum of a long time taken to recover the unique consumption of a project. Consequently, the companies can use the payback period to compare projects in capital arrangements and evaluate the time it takes for the initial venture to recover in years.

Step 2: Calculation of payback with unequal net cash inflows

The payback period (in years) of an investment is computed as follows if net cash inflows are unequal:

Before complete recovery, add the cumulative net cash inflows for full years.

Most popular questions for Business-studies Textbooks

Darren Dillard, majority stockholder and president of Dillard, Inc., is working with his top managers on future plans for the company. As the company’s managerial accountant, you’ve been asked to analyze the following situations and make recommendations to the management team.

Requirements

1. Division A of Dillard, Inc. has $5,250,000 in assets. Its yearly fixed costs are $557,000, and the variable costs of its product line are $1.90 per unit. The division’s volume is currently 500,000 units. Competitors offer a similar product, at the same quality, to retailers for $4.25 each. Dillard’s management team wants to earn a 12% return on investment on the division’s assets.

a. What is Division A’s target full product cost?

b. Given the division’s current costs, will Division A be able to achieve its target profit?

c. Assume Division A has identified ways to cut its variable costs to $1.75 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the division to achieve its target profit?

d. Division A is considering an aggressive advertising campaign strategy to differentiate its product from its competitors. The division does not expect volume to be affected, but it hopes to gain more control over pricing. If Division A has to spend $120,000 next year to advertise and its variable costs continue to be $1.75 per unit, what will its cost-plus price be? Do you think Division A will be able to sell its product at the cost-plus price? Why or why not?

2. The division manager of Division B received the following operating income data for the past year:

DIVISION B OF DILLARD, INC.Income StatementFor the Year Ended December 31, 2018
Product LineTotal
T205B179

Net sales revenue

$310,000

$360,000

$670,000

Cost of goods sold:

Variable

31,000

44,000

75,000

Fixed

275,000

67,000

342,000

The total cost of goods sold

306,000

111,000

417,000

Gross profit

4,000

249,000

253,000

Selling and administrative expenses:

Variable

68,000

80,000

148,000

Fixed

47,000

27,000

74,000

Total selling and administrative expenses

115,000

107,000

222,000

Operating income (loss)

$(111,000)

$142,000

$31,000

The manager of the division is surprised that the T205 product line is not profitable. The division accountant estimates that dropping the T205 product line will decrease fixed cost of goods sold by $75,000 and decrease fixed selling and administrative expenses by $10,000.

a. Prepare a differential analysis to show whether Division B should drop the T205 product line.

b. What is your recommendation to the manager of Division B?

3. Division C also produces two product lines. Because the division can sell all of the product it can produce, Dillard is expanding the plant and needs to decide which product line to emphasize. To make this decision, the division accountant assembled the following data:

Per unit

K707

G582

Sales price

$84

$50

Variable cost

24

21

Contribution margin

$60

$29

Contribution margin ratio

71.4%

58.0%

After expansion, the factory will have a production capacity of 4,700 machine hours per month. The plant can manufacture either 40 units of K707s or 62 units of G582s per machine hour.

a. Identify the constraining factor for Division C.

b. Prepare an analysis to show which product line to emphasize.

4. Division D is considering two possible expansion plans. Plan A would expand a current product line at a cost of $8,600,000. Expected annual net cash inflows are $1,525,000, with zero residual value at the end of 10 years. Under Plan B, Division D would begin producing a new product at a cost of $8,000,000. This plan is expected to generate net cash inflows of $1,100,000 per year for 10 years, the estimated useful life of the product line. Estimated residual value for Plan B is $980,000. Division D uses straight-line depreciation and requires an annual return of 10%.

a. Compute the payback, the ARR, the NPV, and the profitability index for both plans.

b. Compute the estimated IRR of Plan A.

c. Use Excel to verify the NPV calculations in Requirement 4(a) and the actual IRR for the two plans. How does the IRR of each plan compare with the company’s required rate of return?

d. Division D must rank the plans and make a recommendation to Dillard’s top management team for the best plan. Which expansion plan should Division D choose? Why?

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