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Subject P2: Advanced Management Accounting

10.11

Profitability index NPV earned per $1 invested

Discounted Payback The number of times a project recovers the
Profitability Index initial funds invested

Equivalent annual cost The cost of owning, operating and
maintaining an asset over its entire life
expressed as an annuity

Internal rate of return The rate of return at which the project has a
NPV of zero

Accounting rate of return The return generated from profits earned by
the capital invested

Discounted payback period The time required for the present values of
the cash inflows from a project to equal the
present values of the cash outflows

Modified internal rate of return The economic yield of the investment
assuming any cash surpluses are reinvested
at the firm’s current cost of capital

10.12

Calculation of NPV

Year 0 1 2 3 4
$ $ $ $ $
Investment (2,000,000)
Income 1,236,000 1,485,400 2,622,000 1,012,950
Operating costs 676,000 789,372 1,271,227 620,076
–––––––– –––––––– –––––––– –––––––– ––––––––
Net cash flow (2,000,000) 560,000 696,028 1,350,773 392,874
Discount at 10% 1.000 0.909 0.826 0.751 0.683
–––––––– –––––––– –––––––– –––––––– ––––––––
Present values (2,000,000) 509,040 574,919 1,014,430 268,333
–––––––– –––––––– –––––––– –––––––– ––––––––

Net present value: $366,722

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