Question

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 $200,000, has a $14,000 salvage value, is expected to last eleven years, and will generate an after-tax income of $43,000 per year after straight-line depreciation.

Answer 1

Investment 1

After tax income = $ 77,884
Depreciation = (270,000 - 10,000) / 5 = $ 52,000

Cash inflow = 77,884 + 52,000 = $ 129,884

Payback period = 2 Years + [(10,232)/(129,884/365)]/365 = 2.078 years

Investment 2

After tax income = $ 43,000
Depreciation = (200,000 - 14,000)/ 11 = $ 16,909

Cash Inflow = 43,000 + 16,909 = $ 53,909

Payback period = 3 Years + [(20,272,73)/(59,909/365)]/365 = 3.338 years