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ilarly, for the Roo Bag, the payback period would be:
Year Expected cash flows Net cash flows
0 (260,000) (260,000)
1 70,000 (190,000)
2 70,000 (120,000)
3 60,000 (60,000)
4 60,000 0
5 60,000 60,000
From the chart above, we know in the end of year 3, we achieve zero net cash flows, meaning the payback period is 4 year.

In conclusion, the payback period for Beck Bag is 3 years and that for Roo Bag is 4 years.

2. Accounting Rate of Return Calculation
Accounting rate of return is a method to compare the ARR with origin investment and decide whether the investment is feasible and then select a higher ARR from investment plan. Advantages for ARR, it is a simple but useful method and easy to recognize for the users. Also, its data is easy to obtain and we consider all the profit from the plan period.

When calculating the ARR, if the cash flows are the same in the investment period, we just select any year cash flow to divide the origin investment, i.e. Pt=K/A.
If the cash flows are not equal, we should calculate the average annual income, i.e. average cash flow = (C1+C2+C3+……+Ct)/t and use the average cash flow divides origin investment, i.e. Accounting Rate of Return Calculation (ARR) = Average Annual Income/Origin Investment.

Thus, the average annual income for Beck Bag is:
Beck Bag
Year 1 2 3 4 5 Average
Cash flow 60,000 70,000 70,000 40,000 20,000 52,000

ARR=52,000/200,000=26% therefore, the accounting rate of return is 26% for Beck Bag.

Similarly, the average annual income for Roo Bag is:
Beck Bag
Year 1 2 3 4 5 Average
Cash flow 70,000 70,000 60,000 60,000 60,000 64,000

ARR=64,000/260,000=24.6% therefore, the accounting rate of return is 24.6% for Roo Bag.

3. Drawback of Payback Period
Firstly, when using the payback period, we ignore the time value of money. It does not discount the cash flows into the present value and make compare with origin investment (Statman & Sepe, 1984).

Secondly, it neglects the income and profit after the payback period. If the cash flow or income is small and it is not a wise decision for the investment.

Thirdly, the standard for the decision is too simple to set up and it is not based on some theory, merely depends on speculation and easy to manipulate.

4. Drawback of Accounting Rate of Return
Firstly, when using accounting rate of return, we concern about the book value rather than the net cash flows and neglect the effect of discount rate. If the discount factor is large enough, its net present value may be negative since the PV of future cash flows cannot cover the original cost.

Secondly, it ignores effect of the time distribution of net revenue to the economic value of the project. If the cash flows are small at the beginning and become large at the end of the project, the revenue cannot gain a larger income by reinvesting.

5. Reason for Cost Ignorance
The reasons why costs such as market research before a product decision are ignored in investment appraisal calculations are that these costs is SUNK COST, meaning that these costs would occur definitely whether any decisions are selected.

The sunk cost is based on past decision and cannot return or paybac