Question

Ataxia Fitness Center is considering an investment in some additional weight training equipment. The equipment has an estimated useful life of 4 years with no salvage value at the end of the 4 years. Ataxia's internal rate of return on this equipment is 7%. Ataxia's discount rate is also 7%. The payback period on this equipment is closest to (Ignore income taxes.):

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using the tables provided.

4 years

3.39 years

2.00 years

4.49 years

Answer 1

Answer : 3.39 years (Option B)

Explanation :

We know that ,

Pay back period = Intial Investment / Annual Cash Inflows

or , Annual Cash Inflows * Pay back period =  Intial Investment ..... Equation (I)

We also know that

IRR is the rate at which NPV = 0 , or , the rate at which Discounted cash flow = Intial Investment

ie , Annual Cash Inflows * PVIFA _{(7% , 4 years)} =  Intial Investment ..... Equation (II)

Now if we observe equation I & II , we get

Pay back period = PVIFA _{(7% , 4 years)}

By refering PVIFA table the value for 7% in 4 years comes to 3.39

Thus , Pay back period =3.39 years