Compute the payback period for each of these two separate investments: A new operating system for an existing machine is expected to cost $270,000 and have a useful life of five years. The system yields an incremental after-tax income of $77,884 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000. A machine costs $180,000, has a $14,000 salvage value, is expected to last nine years, and will generate an after-tax income of $43,000 per year after straight-line depreciation.
Solution:
a. Annual depreciation = (270000- 10000) / 5 = $52000
Annual cash flows = 77884 + 52000 = $129,884
b. Annual depreciation = (180000- 14000) / 9 = $18,444
Annual cash flows = 43000 + 18444 = $61,444
Payback Period | ||||
Choose Numerator | / | Choose Denominator | = | Payback Period |
Cost of investment | / | Annual net Cash flow | = | Payback Period |
$2,70,000 | / | $1,29,884 | = | 2.08 |
$1,80,000 | / | $61,444 | = | 2.93 |
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