Question

Rooney Company has an opportunity to purchase a forklift to use in its heavy equipment rental business. The forklift would be leased on an annual basis during its first two years of operation. Thereafter, it would be leased to the general public on demand. Rooney would sell it at the end of the fifth year of its useful life. The expected cash inflows and outflows follow:

Year	Nature of Item	Cash Inflow				Cash Outflow
Year 1	Purchase price					$	89,200
Year 1	Revenue	$	36,500
Year 2	Revenue		36,500
Year 3	Revenue		25,500
Year 3	Major overhaul						9,300
Year 4	Revenue		22,500
Year 5	Revenue		20,500
Year 5	Salvage value		8,100

Required

1. a.&b. Determine the payback period using the accumulated and average cash flows approaches. (Round your answers to 1 decimal place.)

Answer 1

a)

Year	Cash flow	Cumulative cash flow
1	-89200+36500=-53300	-52700
2	36500	-52700+36500= -16200
3	25500-9300=16200	-16200+16200=0
4	22500	0+22500=22500
5	20500+8100=28600	22500+28600= 51100

Payback period = Period up to which cumulative cash flow is negative +(cumulative cash flow of that year/ cash flow of next year)

=2 + (16200/16200)

=2+ 1=3 years

2) Initial cost /cash outflow = -89200

Total of annual cash flow over 5 years =36500+36500+25500-9300+22500+20500+8100=140300

Average cash flow over 5 years = 140300/5 = 28060

Payback period = 89200 /28060

               = 3.18 years