Payback & ARR - self-test questions

Why not have a go at the following examples to see how well you have understood the calculation of payback and ARR?

A firm has to choose between two possible projects and the details of each project are as follows:

Capital cost \$000
Project A 300
Project B 500
Project C 450

Net cash inflow (\$000)
Project A Project B Project C
Year 1 75 100 50
Year 2 125 200 75
Year 3 125 300 250
Year 4 100 300 300
Year 5 75 150 200

1

Payback period - Project A

What is the payback period of project A?

2

Payback period - Project B

What is the payback period of project B?

3

Payback period - Project C

What is the payback period of project C?

4

ARR - Project A

What is the average rate of return (ARR) of project A?

5

ARR - Project B

What is the average rate of return (ARR) of project B?

6

ARR - Project C

What is the average rate of return (ARR) of project C?

7

Which project?

Which project would you recommend to the board to accept and why?

The best project on these criteria appears to be project B. It has the lowest payback period (just) of 2 years and 8 months and also has the best ARR figure at 22%.