Hollywood Games operates a video arcade in the Lincoln Mall. The owner of Hollywood Games, Joe L

Hollywood Games operates a video arcade in the Lincoln Mall....

Key Concepts

Payback Period

The payback period is a capital budgeting metric that calculates the time required for an investment to generate cash flows sufficient to recover the initial outlay. It is a simple and intuitive measure of liquidity risk, although it does not account for the time value of money.

Capital Budgeting

Capital budgeting is the process of evaluating and selecting long-term investments that are in line with a company’s goal of maximizing shareholder value. It involves analyzing potential projects or purchases by forecasting their cash inflows and outflows, applying methods such as net present value and payback period to determine if the investment is financially viable.

Straight-Line Depreciation

Straight-line depreciation is a method of expensing the cost of an asset evenly over its useful life. This technique simplifies the allocation process by reducing the asset's value by the same amount each period, which affects both the accounting income and the taxable income.

After-Tax Cash Flow

After-tax cash flow is the net cash that remains after accounting for taxes on revenues and expenses, including depreciation effects. It represents the actual cash benefit generated by an investment once the tax implications are considered, making it an essential component in assessing the viability of a project.

Net Present Value (NPV)

Net Present Value is a capital budgeting technique that calculates the present value of all future cash flows, discounted at the project's cost of capital, and subtracts the initial investment. A positive NPV indicates that the projected earnings exceed the costs, implying a potentially profitable investment.

Accounting Income

Accounting income represents the profitability of an investment as reported in the financial statements, calculated based on revenues and expenses, which include depreciation. It provides a measure of performance over the asset's life but does not necessarily reflect the actual cash flow due to non-cash charges like depreciation.

Accounting Rate of Return

The accounting rate of return is a performance metric used to evaluate an investment by comparing the average accounting income (after depreciation and taxes) to the initial investment cost. It offers an insight into the percentage return expected from the asset based on accounting measures.

Transcript

00:01 So yomi candy company is considering purchasing a second chocolate dip machine in order to expand their business.

00:08 And the information yomi has accumulated regarding the machine is on a table.

00:15 And they estimate that they'll be able to produce more candy using the second machine and increase their annual contribution margin.

00:21 And they also estimate that there will be a small disposal value of the machine.

00:26 But the cost of removal will offset the value.

00:31 And ignore income tax issues on your answers.

00:35 So as you all cash flows occur at the year end except for initial investment accounts, calculate the following for the machine.

00:51 So the first one, what to calculate the net profit value.

01:03 So the formula for net profit value is is the present value of cash flows minus the present value of cash inflows minus present value of cash outflows so for this from the table the npv will be 110 ,400 minus 80 ,000 and the npv will be 30 ,400.

01:42 Now for that the present value of the cash inflows and outflows will be calculated as the following so the present value of the cash inflows would be p open brackets 1 minus 1 plus r waste the power minus n divided by r and r is a periodic payment on p is a periodic payment r is the rate n is number of periods so here we know that p is 15 ,000 r is 6 % and n is 10 years.

02:31 So then the pv of the inflow would be 15 ,000 1 minus 1 plus 0 .06 raised to part 10 divided by 0 .06.

02:50 And then this will be 15 ,000 multiplied by 7 ,360 and this would be 110 ,400 so this is for the inflow now for the outflow it will be the cost of the new machine and that equals to $80 ,000 so moving on to the next question the pay back period so the payback period so the pay period is like the computation of the period of recovery of initial investment from the cash inflows so the formula is initial investments divided by the annual future cash flow inflows and then this is equals to 80 ,000 divided by 15 ,000 and this equals to 5 .23 years so so the payback period for the initial investment is 5 .33 years.

04:28 Now moving on to the next question, the discounted payback period.

04:44 Now for this we'll have to write the number of years, then the cash savings.

04:52 Oh well, i'm going to write it as a table.

04:54 So we have the years from 1 to 10.

05:10 Then we have cash savings.

05:12 So let me number the years for 1 to 10, actually from 0 to 10.

05:51 And then the cash savings, we have 15 ,000 for everything.

06:21 And then the next one is the present value of $1 discounted at 6%.

06:48 And then we have the discounted cash savings and this is 2 multiplied by 3.

07:03 And then we have the cumulative discounted cash savings.

07:16 Savings and then we have the net initial investments uncovered at the end of the year so for the present value of one dollar discounted at 6 % this to be 0 .943 this will be 0 .89 this will be 0 .84 0 .792 0 .747 0 .747 0 .747 0 .705, 0 .665, 0 .627, 0 .627, 0 .592, and 0 .558.

08:38 Now for discounted cash savings, it would be the cash savings times the present value.

08:45 So this would be, so you multiply 2 times 3.

09:25 And then the discounted cash savings is basically adding 1 plus 2 2 plus 3 3 plus 4 just like that 110 ,000 385 now for the next initial investments at the end of the year this is 65 ,000 this is 52 ,505 this is 39 ,905 this is 29 ,905 this is 20 ,0005 this is 20 ,000 5505 this is 8 ,025 this is 16 ,820 this is 6 ,025 and the rest is zeros so we can tell that it's from it's in the seventh year that the initial investments if we scroll down is fully recovered so the initial investment is recovered around the seventh year and the discounted payback period correlation would be calculated as so initial investments is recovered in year 7 and then the discounted payback period will be equals to 6 years and that's 6 ,245 divided by 9 ,975 and this is 6.

12:34 So this is 6 years so this is 6 years plus i'm sorry plus that so this equals to 6 plus 0 .663 and discounted payback period is 6 .63 years now the next question the initial rate of return so this is the method to compute the internal rate is 0 so the initial rate of return using the interpolation method would be.

14:10 So this is the formula and then this will be 10 plus 15 minus 10, multiplied by 12 ,175 divided by 12 ,175 minus 4 ,715.

14:50 So this is equals to 10 plus 3 .6 .6...

Please give Ace some feedback