Question

The Novak Company is planning to purchase $502,100 of equipment with an estimated seven-year life and no estimated salvagc value. The company has projected the following annual cash flows for the investment. Projected Cash Flows Year $193,500 141.500 94,500 79,200 79.200 45,000 45,000 Total $677.900 (a) Calculate the payback period for the proposed equipment purchase. Assume that all cash flows occur evenly throughout the year. Payback period years and months. (b) If Novak requires a payback period of three years or less, should the company make this investment? The company ake this investment. should should not

Answer 1

Payback period: This refers to period in which invertor would get back the amount of investment.

Step 1 -In this case we will find cumulative cash flow for each year

Year	Cash Flow	Cumulative Cash flow
1	$193,500	-
2	$141,500	$335,000
3	$94,500	$429,500
4	$79,200	$508,700
5	$79,200	$587,900
6	$45,000	$632,900
7	$45,000	$677,900

Step 2

The Initial Investment is $502,100 and we can notice that it falls between 3rd and 4th year, and the cash flows occurred evenly throughout the year, so to find out exact payback period we would deduct the cumulative cash flow of 3rd year from initial investment

= $502,100 - 429,500 = $72,600

Step 3

The total cash flow for year 3 is $94,500 occurred evenly through out the year thus to find out exact months we will do following

=(72,600/94500)*13 = 9.21 = 9 months approx

Thus payback period would be 3 years and 9 months

2)

If company wants payback in 3 years or less the company should not invest.