9609 · 10.3.2

Basic methods: payback, accounting rate of return (ARR) — practice questions

Practice and worked examples for 9609 Basic methods: payback, accounting rate of return (ARR). Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Initial investment $200 000. Net cash flows: Year 1 $60 000, Year 2 $80 000, Year 3 $90 000, Year 4 $70 000.$

Calculate the payback period.

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Year	Net CF	Cumulative
0	(200 000)	(200 000)
---	---	---
1	60 000	(140 000)
2	80 000	(60 000)
3	90 000	30 000

Still $60 000 short at end of Year 2. Year 3 inflow = $90 000.

Payback = 2 + (60 000 ÷ 90 000) = 2 + 0.67 = 2 years 8 months (or 2.67 years).

Cumulative turns positive during Year 3.

Worked example 2

Machine costs $150 000. Total profit over 5 years is $75 000. Calculate ARR.

Show solution outline

Average annual profit = $75 000 \div 5 = **$ 15 000**

ARR = ( $15 000 \div$ 150 000) × 100 = 10%

Compare to the firm's target return (e.g. 12%) — here below target, but check other methods and qualitative factors.

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