Question

Exercise 11-5 Payback period computation; even cash flows LO P1

Compute the payback period for each of these two separate investments:

A new operating system for an existing machine is expected to cost $270,000 and have a useful life of five years. The system yields an incremental after-tax income of $77,884 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000.

A machine costs $200,000, has a $14,000 salvage value, is expected to last nine years, and will generate an after-tax income of $43,000 per year after straight-line depreciation.

Answer 1

SOLUTION

Investment - A

Payback period = Cost of investment / Annual net cash flow

= $270,000 / $129,884 = 2.08 years

	Amount ($)
Anuual after-tax income	77,884
Add: Depreciation	52,000
Annual net cash flow	129,884

Depreciation = ($270,000 - $10,000) / 5 years = $52,000

Investment - B

Payback period = Cost of investment / Annual net cash flow

= $200,000 / $63,667 = 3.14 years

	Amount ($)
Anuual after-tax income	43,000
Add: Depreciation	20,667
Annual net cash flow	63,667

Depreciation = ($200,000 - $14,000) / 9 years = $20,667