ACC 115: Management Science

Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

Lesson title: Non-discounted Capital Budgeting Materials:

Techniques Pen and non-scientific calculator
Strategic Cost Management by Cabrera

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Lesson Objectives:
At the end of this module, you should be able to: References:

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1. Evaluate capital investment projects using Managerial Accounting by Hilton

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payback period and accounting rate of return. Strategic Cost Management by Hansen
2. Calculate bailout period and payback and Mowen
reciprocal.

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Productivity Tip:
Exercise. Doing exercise regularly not only helps in staying healthy but it can also give your body
hormones that it needs to be relaxed, focused, and more productive during the day.
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A. LESSON PREVIEW/REVIEW
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1) Introduction
Managers in all organizations periodically face major decisions that involve cash flows over
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several years. Decisions involving the acquisition of machinery, vehicles, buildings, or land are
examples of such decisions. Other examples include decisions involving significant changes in
a production process or adding a new line of products or services to the organization’s activities.
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Decisions involving cash inflows and outflows beyond one year are called capital budgeting
decisions.
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2) Activity 1: What I Know Chart, part 1

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Try answering the questions below by writing your ideas under the first column What I Know.
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What I Know Questions: What I Learned (Activity 4)

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1. What is payback period?

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2. What is the accounting rate of

return?

3. What is payback reciprocal?

B.MAIN LESSON
1) Activity 2: Content Notes

Lesson Objective 1

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

Non-Discounted Capital Budgeting Techniques – capital investment evaluation methods that does
not consider time value of money. The most commonly used methods of non-discounted evaluation
techniques for capital investment decisions will be tackled in this module.

1. Payback Period

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- The amount of time it will take for the net initial investment to be recovered using the annual net

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cash inflows.

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Illustration:
A piece of labor-saving equipment has just come onto the market that Dikosan Electronics could use to

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reduce costs in one of its plants. Relevant data relating to the equipment follow:
Purchase cost of the equipment P432,000

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Annual cost savings that will be provided by the equipment 90,000
Life of the equipment 12 years
The company is subject to 30% tax rate..
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REQUIRED:
a. Compute the payback period for the equipment.
b. If the company requires a payback period of 4 years or less, would the equipment be purchased?
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Solution:
a. In order for us to compute the payback period, first, we must compute the net initial investment and
the net annual cash inflows.
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 Since there is no other information given aside from the purchase price of the equipment, the
net initial investment is ₱432,000.
 The net annual cash inflow in computed as follows:
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After tax cash inflow (90,000 x 70%) 63,000

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Tax shield from depreciation (36,000 x 30%) 10,800

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Net cash inflow 73,800

 The annual depreciation of 36,000 is computed as 432,00 purchase price divided by 12 years.
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We can now compute the payback period of the investment. Since the net cash inflow is assumed to be
the same every year, we can simply divide the net initial investment by the net cash inflow.
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 The investment of 432,000 on the project takes 5.85 years to recover given the annual net cash
inflows.

b. A company would always prefer a shorter payback period. If the payback period is shorter or equal to
the required payback period of the company, the investment should be pursued. Otherwise, reject it. In
problem, the company requires a payback period of 4 years or less, then the equipment should not be
purchased.

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

2. Accounting Rate of Return

- Measures the profitability by relating the net initial investment of an investment with the future
annual income that can be generated from it.

Illustration:

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Required: Using the same problem in the payback period,

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a. Compute the accounting rate of return promised by the equipment based on original investment
(simple rate of return). Would the equipment be purchased if the company's required rate of return is

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14%?
b. Compute the accounting rate of return promised by the equipment based on average investment.

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Would the equipment be purchased if the company's required rate of return is 14%?

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Solution:
a. In order for us to compute the accounting rate of return, we must know the net initial investment and
the annual net income of the project. Since we already know the net initial investment, then we must
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compute the annual net income. It is computed as follows:
Net cash inflows 73,800
Less: Annual depreciation 36,000
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Net income 37,800

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We can now compute the accounting rate of return based on original investment by diving the net
income with the net initial investment.
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
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If the company requires an accounting rate of return of 14%, then the equipment should not be
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purchased. A higher accounting rate of return is always preferred.

b. Before we compute the accounting rate of return based on average investment, we have to
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determine first the average investment. The average investment is computed as follows:
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We can now proceed in computing the initial investment based on average investment.

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

 A higher accounting rate of return is always preferred. If the accounting rate of return is greater
than or equal to the required rate of return of a project, then the project should be pursued.
Otherwise, reject it. In the problem, the company requires an accounting rate of return of 14%,
then based on average investment, the equipment should be purchased.

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3. Bail-out Period
- a version of the payback period that considers the salvage value on the investment.

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Illustration:

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A Company purchased a new machine on January 1 of this year for P45,000, with an estimated useful
life of 5 years and a salvage value of P5,000. The machine will be depreciated using the straight-line

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method. The machine is expected to produce cash flow from operations, net of income taxes, of
P18,000 a year in each of the next five years. The new machine's salvage value is P10,000 in years 1
and 2, and P7,500 in years 3 and 4.
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REQUIRED: Compute the bailout period for this new machine.

Solution:
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Salvage
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Year Balance Cash Flow Value Total Bail-out period

1 45,000 18,000 10,000 28,000 1
2 27,000 18,000 10,000 28,000 0.94
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Bail-out period 1.94 years

 Using bait-out period, we should know the amount of time the initial investment of 45,000 can be
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recovered with the cash flow and salvage value.

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 In year 1, the initial investment of 45,000 is not fully recovered by the combined cash flow and
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salvage value of 28,000.

 In year 2, the balance of initial investment was reduced by the cash flow of 18,000 so it became
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27,000 (45,000 – 18,000 = 27,000). The balance will not be reduced by the salvage value
because the salvage value does not constitute cash inflow until it is sold at the end of its useful
life.
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 Also in year 2, the balance of 27,000 will be fully recovered by the combined cash flow and
salvage value of 27,000. To know the exact amount of time when the balance can be recovered
in year 2, we can use this formula:

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

The bailout period for the investment is 1.94 years. To evaluate the payback period, a shorter
amount of time is preferred just like in payback period.

4. Payback Reciprocal

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- The rate of recovery of investment during the payback period.

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Payback reciprocal can be computed as follows:

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Or

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Illustration:
Required: Using the problem in the payback period, compute the payback reciprocal.
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Solution:
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Or
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Note: A higher figure for payback reciprocal is preferred.

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

2) Activity 3: Skill-building Activities

Masipag has an investment opportunity costing ₱300,000 that is expected to yield the following cash
flows over the next six years:
Year One ₱75,000 Year Four ₱130,000
Year Two ₱90,000 Year Five ₱100,000

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Year Three ₱115,000 Year Six ₱90,000

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Required:
a. Find the payback period of the investment.

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b. Find the accounting rate of return based on average investment.

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Check your answers against the Key to Corrections found at the end of this SAS. Be sure to complete
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each activity before looking. Write your score on your paper.

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3) Activity 4: What I Know Chart, part 2

Let us see how your knowledge changed by reviewing the questions in the What I Know Chart
from Activity 1. Write your answers to the questions based on what you now know in the third
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column of the chart.

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4) Activity 5: Check for Understanding

Test 1
Masikap has an investment opportunity costing ₱180,000 that is expected to yield the following cash
flows over the next five years:
Year One ₱ 30,000
Year Two ₱ 60,000
Year Three ₱ 90,000
Year Four ₱ 60,000
Year Five ₱ 30,000
Required:
a. Find the payback period of the investment.
b. Find the accounting rate of return of based on original investment.

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

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Test 2
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An investment of 150,000 is expected to produce annual cash earnings of ₱50,000 for 5 years. Its
estimated salvage value is 70,000 during the first year and this is expected to decrease by ₱15,000
annually.
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Required: Compute the bail-out period.

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 ACC 115: Management Science
Student Activity Sheet #21

Name: _________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________ Date: ________________

C. LESSON WRAP-UP
1) Activity 6: Thinking about Learning
Congratulations for finishing this module! Shade the number of this module that you just have finished.

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What part of the topic did you find difficult? ______________________ ________________

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_____________________________________________________________________________________________________________

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What is your favorite part of the module? ________________________________________________________________

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_____________________________________________________________________________________________________________
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FAQs
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Question 1: What am I going to use, original investment or average investment, when an accounting
problem is silent on where to base the accounting rate of return?
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Answer: If the problem is silent, use average investment. But, if the problem is requiring you to
compute simple rate of return, then it should be based on original investment.
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KEY TO CORRECTIONS
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Skill Building Activity

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a. Payback period: 3.15 years

300,000 – (75,000 + 90,000 + 115,000) = 20,000  3 years
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20,000 ÷ 130,000  0.15

Payback Period = 3.15 years
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b. Book rate of return: 33.3%

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Total cash flows for 6 years = 600,000

Average return: ₱100,000 (₱600,000 total / 6 years)
Depreciation: 50,000 (₱30,000 / 6 years)
Average income ₱50,000 (100,000 average annual return – 50,000 depreciation)

Average investment: ₱300,000 / 2 = ₱150,000

Accounting rate of return = ₱50,000 / 150,000 = 33.33%

Assignment:
Read about discounted capital budgeting techniques in your book on pages 430 – 446.

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