Question

Exercise 24-5 Payback period computation; even cash flows LO P1

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

1. A new operating system for an existing machine is expected to cost $250,000 and have a useful life of six years. The system yields an incremental after-tax income of $72,115 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000.
2. A machine costs $180,000, has a $13,000 salvage value, is expected to last eleven years, and will generate an after-tax income of $39,000 per year after straight-line depreciation.

Answer 1

1st case;

let us know the amount of annual depreciation;

=> (cost - salvage value) / number of years

=>(250,000-10,000)/ 6 years.

=>$60,000.

annual cash flow = after tax income + depreciation =72,115 +60,000

=>$132,115.

pay back period of uniform cash flows = $250,000/132,115

=>1.89 years.

2nd part;

let us know the annual depreciation ;

($180,000-13,000) / 11 years.

=>$15,182

annual cash flow =after tax income + depreciation= $39,000+15,182

=>$54,182

pay back period = $180,000 / 54,182

=>3.32 years.