Question

1. Determine the payback period in years for a project that costs $42,000 and would yield after-tax cash flows of $7,000 the first year, $9,000 the second year, $12,000 the third year, $14,000 the fourth year, $18,000 the fifth year, and $24,000 the sixth year.

2. You are evaluating a potential investment in equipment. The equipment's basic price is $126,000, and shipping costs will be $3,800. It will cost another $18,900 to modify it for special use by your firm, and an additional $6,300 to install it. The equipment falls in the MACRS 3-year class that allows depreciation of 33% the first year, 45% the second year, 15% the third year, and 7% the fourth year. You expect to sell the equipment for 23,300 at the end of three years. The equipment is expected to generate revenues of $115,000 per year with annual operating costs of $61,000. The firm's marginal tax rate is 30.0%. What is the after-tax operating cash flow for year 2?

Answer 1

Payback period refers to the time period needed in order to recover the initial outflows for a project.

In order to determine the payback period for a project with uneven cash flows, the following steps are required:

Year	Net cash flow	Cumulative cash flow
Y0	(42000)	(42000)
Y1	7000	(35000)
Y2	9000	(26000)
Y3	12000	(14000)
Y4	14000	0
Y5	18000	18000
Y6	24000	42000

In the above table, we can observe that at the end of year 4, the total initial cost has been recovered.

Thus, payback period in this case is 4 years.