Question

Management of Skywards, Inc., an airline caterer, is purchasing refrigerated trucks at a total cost of $3.25 million. After-tax net income from this investment is expected to be $750,000 for the next five years. Annual depreciation expense will be $650,000. The cost of capital is 17 percent. a. What is the discounted payback period? PLEASE explain the formula used for discount payback period!

Answer 1

Cash flows per year=Net Income+Depreciation=750000+650000=1400000

Cumulative discounted cash flows at the end of year 0=-3.25 million

Cumulative discounted cash flows at the end of year 1=-3.25+1.4/1.17=-2.053418803

Cumulative discounted cash flows at the end of year 2=-2.053418803+1.4/1.17^2=-1.030699832

Cumulative discounted cash flows at the end of year 3=-1.030699832+1.4/1.17^3=-0.156581053

Cumulative discounted cash flows at the end of year 4=-0.156581053+1.4/1.17^4=0.590529015

As here cumulative cash flows became positve in year 4, we will use 4-1=3 below

Hence, discounted payback period is=period where cash flow was last negative-cumulative cash flows in that period/discounted cash flows only in the next period=3+0.156581053/(1.4/1.17^4)=3.209582309 years