Question

Compute the payback period for each of these two separate investments:

1. A new operating system for an existing machine is expected to cost $270,000 and have a useful life of six 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.
2. 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

First investment;

annual depreciation = (cost - salvage value)/ number of years

=>($270,000-10,000) / 6 years

=>$43,333.33.

annual cash flow = incremental after tax income + annual depreciation

=>$77,884+43,333.33

=>$121,217.33.

payback period = initial investment / annual cash flow

=>$270,000 / 121,217.33

=>2.23 years.

second part;

annual depreciation = ($200,000 cost - 14,000 salvage value) / 11 years

=>$16,909.09.

annual cash flow = after tax income + depreciation

=>$16,909.09+43,000

=>$59,909.09.

payback period = $200,000 / 59,909.09

=>3.34 years.

Second investment;