Managerial Accounting Quiz: Payback And Accounting Rate Of Return
6 questions · exam conditions
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Payback And Accounting Rate Of ReturnQuestion 1 of 6

Arctic Ltd is comparing two investment alternatives. Project X requires $400,000 initially and generates cash flows of $95,000, $110,000, $125,000, $140,000, and $80,000 over five years. Project Y requires $450,000 initially and generates $130,000 annually for four years. If the company prioritizes shorter payback periods but requires minimum 20% accounting rate of return, which conclusion is most appropriate?

Select Project X due to superior payback period of 3.68 years versus Project Y's 3.46 years
Select Project Y due to superior payback period of 3.46 years versus Project X's 3.68 years
Reject both projects since neither meets the 20% ARR requirement despite acceptable payback periods
Select Project X since it meets both payback and ARR criteria while Project Y only meets payback
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Managerial Accounting Quiz

Managerial Accounting Quiz: Payback And Accounting Rate Of Return

Practice Payback And Accounting Rate Of Return in Managerial Accounting with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Payback And Accounting Rate Of Return, giving you a quick way to practice the rules, question types, and explanations that matter most for Managerial Accounting.

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Question 1

Arctic Ltd is comparing two investment alternatives. Project X requires $400,000 initially and generates cash flows of $95,000, $110,000, $125,000, $140,000, and $80,000 over five years. Project Y requires $450,000 initially and generates $130,000 annually for four years. If the company prioritizes shorter payback periods but requires minimum 20% accounting rate of return, which conclusion is most appropriate?

  1. Select Project X due to superior payback period of 3.68 years versus Project Y's 3.46 years
  2. Select Project Y due to superior payback period of 3.46 years versus Project X's 3.68 years (correct answer)
  3. Reject both projects since neither meets the 20% ARR requirement despite acceptable payback periods
  4. Select Project X since it meets both payback and ARR criteria while Project Y only meets payback
Explanation: Project X payback: $95K + $110K + $125K = $330K after 3 years. Need $70K more. $70K ÷ $140K = 0.5. Payback = 3.5 years. Project Y payback: $450K ÷ $130K = 3.46 years. Project Y has shorter payback, so if prioritizing payback, select Y. Choice A reverses the payback periods. Choices C and D require ARR calculations not fully provided in the scenario setup, making the payback comparison the primary decision factor.

Question 2

Meridian Corp is evaluating a new packaging machine with an initial cost of $240,000. The machine will generate annual net cash inflows of $45,000 for years 1-3, $60,000 for years 4-6, and $30,000 for years 7-8. Annual depreciation expense is $30,000. If the company requires a payback period of no more than 5.5 years, what can be concluded about this investment?

  1. The project should be accepted since the payback period is exactly 5.0 years
  2. The project should be rejected since the payback period is 5.8 years
  3. The project should be accepted since the payback period is 4.7 years (correct answer)
  4. The project should be rejected since the payback period cannot be determined with uneven cash flows
Explanation: Payback period calculation: Years 1-3: $45,000 × 3 = $135,000 cumulative. Years 4-6: $60,000 × 1 = $60,000, bringing cumulative to $195,000 after 4 years. Remaining needed: $240,000 - $195,000 = $45,000. In year 5: $45,000 ÷ $60,000 = 0.75 years. Total payback = 4 + 0.75 = 4.75 years, which is less than 5.5 years, so accept. Choice A uses wrong calculation. Choice B incorrectly includes depreciation in cash flows. Choice D is wrong because payback can be calculated with uneven flows.

Question 3

Coastal Corp is analyzing an expansion project requiring $600,000 initial investment. The project will generate the following annual cash flows: Years 1-2: $120,000 each; Years 3-5: $180,000 each; Year 6: $100,000. Annual depreciation is $100,000, and additional working capital of $50,000 is required initially but recovered at project end. What is the project's payback period?

  1. 3.33 years, calculated using total cash investment including working capital recovery timing
  2. 4.17 years, calculated using initial equipment cost and including depreciation tax benefits
  3. 3.61 years, calculated using total initial investment and operating cash flows only (correct answer)
  4. 4.00 years, calculated using net present value approach for uneven cash flows
Explanation: Total initial investment = $600,000 + $50,000 = $650,000. Cumulative cash flows: Year 1: $120,000; Year 2: $240,000; Year 3: $420,000; Year 4: $600,000. After 3 years, need $650,000 - $420,000 = $230,000 more. In year 4: $230,000 ÷ $180,000 = 0.61 years. Payback = 3 + 0.61 = 3.61 years. Choice A ignores working capital in initial investment. Choice B incorrectly includes depreciation. Choice D confuses payback with NPV calculation method.

Question 4

Nova Industries purchased equipment for $720,000 that will save $95,000 annually in operating costs and generate $45,000 in additional annual revenue over 8 years. The equipment has a $80,000 salvage value and will be depreciated using straight-line method. What is the accounting rate of return using the average investment approach?

  1. 17.5% based on total annual benefits of $140,000 and average investment of $400,000
  2. 15.0% based on net annual income of $60,000 and average investment of $400,000 (correct answer)
  3. 19.4% based on annual cash savings of $140,000 and initial investment of $720,000
  4. 12.5% based on net annual income after depreciation and average investment calculation
Explanation: Total annual benefits = $95,000 + $45,000 = 140,000.Annualdepreciation=(140,000. Annual depreciation = (720,000 - $80,000) ÷ 8 = $80,000. Net annual income = $140,000 - $80,000 = 60,000.Averageinvestment=(60,000. Average investment = (720,000 + $80,000) ÷ 2 = $400,000. ARR = $60,000 ÷ $400,000 = 15.0%. Choice A uses cash flow instead of net income. Choice C uses initial investment instead of average. Choice D has calculation error in the income or investment figure.

Question 5

Phoenix Industries has two mutually exclusive projects with identical $300,000 initial investments. Project Alpha has a 3.2-year payback period and generates $110,000 average annual accounting income. Project Beta has a 4.1-year payback period and generates $95,000 average annual accounting income. Both projects have 8-year useful lives with zero salvage values. Which project should be selected if both payback period and accounting rate of return are considered equally important?

  1. Project Alpha because it has both superior payback period and higher accounting rate of return performance (correct answer)
  2. Project Beta because its longer payback period indicates more stable and predictable cash flows
  3. Project Alpha because payback period is more important than accounting rate of return for capital rationing decisions
  4. The projects are equivalent since they require identical initial investments and have similar useful lives
Explanation: Project Alpha: ARR = $110,000 ÷ $300,000 = 36.7%; Payback = 3.2 years. Project Beta: ARR = $95,000 ÷ $300,000 = 31.7%; Payback = 4.1 years. Alpha is superior on both measures (shorter payback and higher ARR). Choice B incorrectly interprets longer payback as positive. Choice C makes an unsupported assumption about capital rationing. Choice D ignores the performance differences shown by both metrics.

Question 6

Zenith Corporation is evaluating whether to replace its current production line. The existing equipment has a remaining useful life of 6 years, generates $200,000 annual cash flows, and has zero salvage value. The replacement equipment costs $900,000, would generate $350,000 annual cash flows for 6 years, and has a $150,000 salvage value. Annual depreciation on the new equipment would be $125,000.

Using incremental analysis, what is the payback period for the replacement decision?

  1. 6.0 years since the incremental cash flows of $150,000 annually exactly recover the investment (correct answer)
  2. 5.4 years calculated using incremental cash flows and including salvage value recovery timing
  3. 7.2 years calculated using net incremental income after depreciation expenses are considered
  4. 4.5 years calculated using total new equipment cash flows versus total investment cost
Explanation: Incremental cash flows = $350,000 - $200,000 = $150,000 annually. Payback period = $900,000 ÷ $150,000 = 6.0 years. The salvage value is not considered in payback period calculation as it occurs at the end of the project life. Choice B incorrectly includes salvage value timing. Choice C uses net income instead of cash flows. Choice D uses total cash flows instead of incremental analysis.