Question

Heidi Company is considering the acquisition of a machine that costs $420,000. The machine is expected to have a useful life of 6 years, a negligible residual value, an annual net cash flow of $120,000, and annual operating income of $83,721. What is the estimated cash payback period for the machine?

Answer 1

Concepts and reason

Capital budgeting: Huge projects like setting up a new plant, expanding existing business, and acquiring new businesses take huge amount of capital investments. Capital budgeting techniques help evaluation of these kind of investments.

Fundamentals

Payback period: Payback period calculates the amount of time required to recover the investment in the project. It is a simple but effective measure of understanding proposed project. It is generally calculated without considering the effect of time value of money but another version is also available which considers the time value of money.

Investment required in the machine is $420,000. Amount to be recovered is $420,000. Each year an equal amount of cash is expected to be received from the business. Cash payback period then is:

Payback period is the time required to recover investment in the project. Cash payback period is:

Thus, payback period is

Ans:

Payback period is 3.5 years.