Question

Compute the payback period for each of these two separate investments: a. A new operating system for an existing machine is expected to cost $260,000 and have a useful life of four years. The system yields an incremental after-tax income of $75,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000. b. A machine costs $170,000, has a $14,000 salvage value, is expected to last nine years, and will generate an after-tax income of $41,000 per year after straight-line depreciation. Payback Period Choose Numerator: 1 Choose Denominator: = Cost of investment / Annual net cash flow $ 260,000/ bS 170,000 $ 58,333) = Payback Period Payback period 2.91 years

Answer 1

ANSWER:

Payback period = cost of investment/annual net cash flow

Annual net cash flow = annual net income + annual depreciation

therefore,

(a)

Depreciation per annum (by straight line method) = (initial cost - salvage value)/useful life

= ($260000 - $10000)/4 = $62500

Therefore,

Annual net cash flow = $75000 + $62500 = $137500

Therefore,

Payback period = $260000/$137500

= 1.89 years

(b)

Depreciation per annum (by straight line method) = (initial cost - salvage value)/useful life

= ($170000 - $14000)/9 = $17333.33

Therefore,

Annual net cash flow = $41000 + $17333.33 = $58333.33

Therefore,

Payback period = $170000/$58333.33

= 2.91 years