Question

Pique Corporation wants to purchase a new machine for $270,000. Management predicts that the machine can produce sales of $160,000 each year for the next 4 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $69,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40.00%. Management requires a minimum after-tax rate of return of 10.00% on all investments.

What is the present value payback period, rounded to one-tenth of a year? Use Excel PV in your calculations.

A.3.0

B.N/A cumulative cash flow is always negative

C.4.0

D.6.0

E.5.0

Answer 1

Initial cost of equipment: $270000

Annual cash inflows:

Sales: $160000

Annual cash Outflows:

Expenses -69000

Income Tax

income - 160000

less expenses 69000

less Depreciation 67500

Net Income 23500

Tax On 23500*40% 9400

Non cash expenses:

Depreciation expense: $67500

Step 1: In order to compute the payback period of the equipment, we need to workout the net annual cash inflow by deducting the total of cash outflow from the total of cash inflow associated with the equipment.

Computation of net annual cash inflow:

$160000 – ($69000+9400)
= $81600

Step 2: Now, the amount of investment required to purchase the equipment would be divided by the amount of net annual cash inflow (computed in step 1) to find the payback period of the equipment.

= $270000/$81600

3.3 Years

Payback period is 3.3 years

Note Depreciation is a non-cash expense and has therefore been ignored while calculating the payback period of the project.