Question

(Ignore income taxes in this problem.) Neighbors Corporation is considering a project that would require an investment of $289,000 and would last for 8 years. The incremental annual revenues and expenses generated by the project during those 8 years would be as follows:

Sales	$254,000
Variable expenses	24,000
Contribution margin	230,000
Fixed expenses:
Salaries	27,000
Rents	40,000
Depreciation	35,000
Total fixed expenses	102,000
Net operating income	$128,000

The scrap value of the project's assets at the end of the project would be $17,000. The cash inflows occur evenly throughout the year. The payback period of the project is closest to:

2.1 years

2.3 years

1.7 years

1.8 years

Answer 1

The pay-back period can be ascertained in the following manner:

1. Calculate annual net earnings (profits) before depreciation and after taxes; these are called annual cash flows.
2. Divide the initial outlay (cost) of the project by the annual cash inflow, where the project generates constant annual cash inflows.

Thus, where the project generates constant cash inflows=

= Cash outlay of the project or Original cost of the assets / Annual cash inflows

Original cost of the assets is = $ 289,000

(- ) Salvage value of the project = $   17,000

Cost of initial investment after salvage = $ 272,000

Annual cash inflow before depreciation = $ 163,000 (operating income $ 128,000 + depreciation $ 35,000)

= 272,000/163,000

= 1.6687 Years (or) 1.7 Years