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 $240,000 and have a useful life of six years. The system yields an incremental after-tax income of $69,230 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $9,000.
2. A machine costs $210,000, has a $13,000 salvage value, is expected to last seven years, and will generate an after-tax income of $38,000 per year after straight-line depreciation.

Answer 1

	Payback Period = Cost of investment / Annual net cash flow
a)	Cost of investment	$             2,40,000
	Annual Cash flow	$             1,07,730
	Payback Period	2.23 years
	(240000/107730)
	Annual cash flow
	Annual After-tax income	$                 69,230
	Add: Depreciation	$                 38,500
	(240000-9000)/6	$             1,07,730
b)	Cost of investment	$             2,10,000
	Annual Cash flow	$                 66,143
	Payback Period	3.17 years
	(210000/66143)
	Annual cash flow
	Annual After-tax income	$                 38,000
	Add: Depreciation	$                 28,143
	(210000-13000)/7	$                 66,143