S. M.

Mahruf Billah

6 (b)
ABO enterprise is reviewing an investment proposal. The initial cost and estimates of the book value of
the investment at the end of each year, the net cash flows for each year, and the net income for each
year are presented in the schedule below. All cash flows are assumed to take place at the end of the
year. The residual value of the investment at the end of each year is equal to its book value. There
would be no residual value at the end of the investment’s life. (96th AIBB May-June 2023)
Investment proposal
Year Initial Cost and Annual Cash flows Annual net income
Book value (taka) (taka)
(taka)
0 1,05,000 - -
1 70,000 45,000 16,000
2 42,000 40,000 18,000
3 21,000 35,000 20,000
4 7,000 30,000 22,000
5 0 25,000 24,000
ABO enterprise uses a 15% target rate of return for new investment proposals. Discount factors are as
follows:
Year Discount factor, 15%
1 0.86957
2 0.75614
3 0.65752
4 0.57175
5 0.49718
You are required to calculate:
i. Cash payback period for the proposal.
ii. The Annual Rate of Return (ARR) for the investment.
iii. The Net Present Value (NPV) of the investment.
Solution:
i.
Year 0 1 2 3 4 5
Net cash flow -1,05,000 45,000 40,000 35,000 30,000 25,000
Cumulative net cash flow -1,05,000 -60,000 -20,000 15,000 45,000 70,000

Formula for Payback period:

𝑈𝑛𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑒𝑑 𝑐𝑜𝑠𝑡 𝑎𝑡 𝑠𝑡𝑎𝑟𝑡 𝑜𝑓 𝑓𝑢𝑙𝑙 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑦𝑒𝑎𝑟
𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑃𝑒𝑟𝑖𝑜𝑑 = 𝑌𝑒𝑎𝑟𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑓𝑢𝑙𝑙 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 +
𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑖𝑛 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑦𝑒𝑎𝑟

20000
So, Payback Period = 2 + = 2.57 𝑌𝑒𝑎𝑟𝑠
35000
ii.
1,05,000 + 0
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = = 52,500 𝑡𝑎𝑘𝑎
2
 S. M. Mahruf Billah

{(16,000 + 18,000 + 20,000 + 22,000 + 24,000)/5}

𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = = 0.380 = 38%
52,500
iii.
Year Cash flows (taka) Discount factor Present value
at 15% (taka)
1 45,000 .86957 39,130
2 40,000 .75614 30,245
3 35,000 .65752 23,013
4 30,000 .57175 17,152
5 25,000 .49718 12,429
Present value of cash flows 1,21,969
Initial investment 1,05,000
Net present value 16,969