Question

Baird Company has an opportunity to purchase a forklift to use in its heavy equipment rental business. The forklift would be leased on an annual basis during its first two years of operation. Thereafter, it would be leased to the general public on demand. Baird would sell it at the end of the fifth year of its useful life. The expected cash inflows and outflows follow:

 

Year	Nature of Item	Cash Inflow				Cash Outflow
Year 1	Purchase price					$	79,800
Year 1	Revenue	$	31,000
Year 2	Revenue		31,000
Year 3	Revenue		26,000
Year 3	Major overhaul						8,200
Year 4	Revenue		17,000
Year 5	Revenue		15,000
Year 5	Salvage value		7,000

 

Required

1. a.&b. Determine the payback period using the accumulated and average cash flows approaches. (Round your answers to 1 decimal place.)

 

 

 

Answer 1

a. Determine the payback period using the accumulated cash flows approach.

Purchase Price	$79,800
Year	Annual Amount	Cumulative Amount
1	$31,000	$31,000
2	31,000	62,000
3	26,000	88,000
Payback	Period	3 years

b. Determine the payback period using the average cash flows approach.

 

Average annual net cash inflow= (Cash inflows - Cash outflows) / Expected # of cash flow years

Cash inflows is found by adding all cash inflows

Cash outflows is found by adding all cash outflows

Average annual net cash inflow= ( $127,000 - $8,200 ) / 5

Average annual net cash inflow= $23,760

Payback Period = net cost of investment / Average annual net cash inflow

Payback Period = $79,800 / $23,760

Payback Period = 3.35 years

a. The payback period is 3 years

b. the Payback period is 3.4 years