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 $280,000 and have a useful life of four years. The system yields an incremental after-tax income of $80,769 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $11,000. b. A machine costs $210,000, has a $15,000 salvage value, is expected to last ten years, and will generate an after-tax income of $44,000 per year after straight-line depreciation. Payback Period Choose Numerator: Cost of investment Choose Denominator:Payback Period Annual net cash flowPayback period 4.01 years 2.87 years 280,000 I 200,000 I 69,769 69,769

Answer 1

Ans: Computation of Payback period for 2 separate departments

Calculations of Annual cash flows

Investment a. Investment b

Annual cashflow $80,769 $44,000

Add: Depreciation $67,250 $19,500

Net Cash flows $1,48,019 $63,500

Payback period

a. $2,80,000 / $1,48,019 =1.89 years

b. $2,00,000. / $63,500 . =3.14 years

Note:

Depreciation should added back to cash flows because it is a non cash expense and does not effect cash flow but we can claim tax deduction

Investment a. Investment b

Cost $ 2,80,000 . $2,10,000

Salvage value. $11,000. $15,000

Life of machine. 4. 10

Depreciation= (cost- salvage value) /life of an asset

Depreciation $ 67,250. $19,500