Question

A client of yours is experiencing expanding of his business rapidly, he needs to consider if...

A client of yours is experiencing expanding of his business rapidly, he needs
to consider if he should purchase a new machine for his business. He has
come to you for your advice. The relevant details are provided below,
• Machine cost $120,000
• Expected operating life 5 years
• Expected scrap value at the end of 5 years $20,000
• Annual depreciation $20,000
• Expected annual cash inflows from operations $40,000
a. What is the payback period? Please show calculation.
b. What is the advantages and disadvantages of using payback period as
your investment decision?

Business   Accounting   
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Homework Answers

Answer #1

Pay back period = Initial Investment / Annual cash inlfow

= 120000 / 40000 = 3 Years

Advantages

* Easy to calculate

* Can use to compare various projects

* This method reduces or aviods loss through obsolescence

* This method focus on speedy recovery of initial investment.

Disadvantages

* Does not consider time value of money.

* Does not consider projects profitability

* Does not consider projects return on investment.

* This method ignores short term solvency.

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