What is the payback period and accounting rate of return for RP Investments Ltd's recent investment in new equipment?
Calculating the payback period for RP Investments Ltd's investment involves summing up the annual cash inflows until they equal the initial investment. In this case, the payback period is determined to be 3.15 years.
The accounting rate of return (ARR) for the investment is calculated as 46.67%.
Payback Period Calculation
The payback period is a measure of how long it takes for an investment to generate enough cash flows to recover the initial investment. For RP Investments Ltd's investment, the payback period is calculated as follows:
Payback Period = 3 + (R550,000 - R540,000) / R650,000 = 3.15 years
Accounting Rate of Return Calculation
The accounting rate of return (ARR) calculates the average annual profit as a percentage of the average investment. For RP Investments Ltd's investment, the ARR is calculated as:
ARR = (Average Annual Profit / Average Investment) x 100
Step 1: Compute the average annual profit.
Average Annual Profit = (R220,000 + R200,000 + R120,000 + R110,000 + R50,000) / 5 = R140,000
Step 2: Compute the average investment.
Average Investment = (Initial Investment + Salvage Value) / 2 = (R550,000 + R50,000) / 2 = R300,000
ARR = (R140,000 / R300,000) x 100 = 46.67%
The payback period for RP Investments Ltd's new equipment investment is 3.15 years, and the accounting rate of return is 46.67%. This indicates that the investment is expected to generate returns and is financially viable.