12-3. Continued c. The $200,000 in depreciation provided a cash flow benefit of $80,000 Cash flow(b) $200.000 Cash flow(a) 120.000 Cash flow benefit $80,000 d. The president of a New York Stock Exchange firm might not be satisfied by the results provided by depreciation. Although depreciation increased cash flow by $80,000, it decreased earnings after taxes by $120,000 down to zero. CEOs tend to be very sensitive to earnings performance. Although this is not necessarily rational, it is likely to be true Assume a $40,000 investment and the following cash flows for two alternatives Investment X Investment y 112345 $6,000 $15,000 8.000 20.000 9.000 10,000 17,000 000 Which of the alternatives would you select under the pay back method? Solution: Payback for Investment X Payback for Investment Y $40000-$60001year $40000-$150001year 34,000-8,0002 years 25.000-20.000 26,000-90003 years 5000/10,0005 years 17,000-17,0004 years Payback Investment X=4.00 years Payback Investment Y=2.50 years Investment Y would be selected because of the faster payback CopyrightC 2005 by The McGray-Hill Companies, Inc. S-426Copyright © 2005 by The McGraw-Hill Companies, Inc. S-426 12-3. Continued c. The $200,000 in depreciation provided a cash flow benefit of $80,000. Cash flow (b) $200,000 Cash flow (a) 120,000 Cash flow benefit $ 80,000 d. The president of a New York Stock Exchange firm might not be satisfied by the results provided by depreciation. Although depreciation increased cash flow by $80,000, it decreased earnings after taxes by $120,000 down to zero. CEOs tend to be very sensitive to earnings performance. Although this is not necessarily rational, it is likely to be true. 12-4. Assume a $40,000 investment and the following cash flows for two alternatives. Year Investment X Investment Y 1 ............ $ 6,000 $15,000 2 ............ 8,000 20,000 3 ............ 9,000 10,000 4 ............ 17,000 5 ............ 20,000 Which of the alternatives would you select under the payback method? Solution: Payback for Investment X Payback for Investment Y $40,000 – $ 6,000 1 year $40,000 – $15,000 1 year 34,000 – 8,000 2 years 25,000 – 20,000 2 years 26,000 – 9,000 3 years 5,000/10,000 .5 years 17,000 – 17,000 4 years Payback Investment X = 4.00 years Payback Investment Y = 2.50 years Investment Y would be selected because of the faster payback