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 $280,000 and have a useful life of six years. The system yields an incremental after-tax income of $80,769 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $11,000.

A machine costs $180,000, has a $15,000 salvage value, is expected to last eight years, and will generate an after-tax income of $44,000 per year after straight-line depreciation.

Answer 1

Payback period = initial investment/annual cash inflow

WN: calculation of depreciation = cost of the machine- salvage value/ life of the machine

a) Deprciation of first machine= 280,000-11,000/6=44,833 (round off)

b) Depreciation of second machine= 180,000-15,000/8=20,625

solution:

first machine:

initial investment= 280,000

annual cash inflow= cash inflow after depreciation+ depreciation= 80,769+44,833= 125,602

Payback period = 280,000/125,602= 2.23 years

second machine:

initial investment= 180,000

annual cash inflow= 44,000+20,625= 64,625

Payback Period= 180,000/64,625=2.79 years