Question

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

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.

A machine costs $180,000, 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

a)

given data

machine cost = 240000

estimated life = 6 years

salvage value = 9000

after tax income = 69230

calculation of annual cash flow :

after tax income	69230
annual depriciation (working note 1)	38500
annual cash flow	107730

working note 1:

depreciation (straight line method) = (cost of machinary - salvage value) / estimated life

= (240000 - 9000) /6

= 38500

COMPUTATION OF PAYBACK PERIOD :

payback period = cost of investment / annual net cash flow

payback period = 240000 / 107730

= 2.22 years

b)

given data

machine cost = 180000

salvage value = 13000

estimated life = 7 years

after tax income = 38000

calculation of annual cash flow :

after tax income	38000
annual depreciation (working note 2)	23857.14
net cash flow	61857.14

CALCULATION OF PAYBACK PERIOD :

payback period = cost of investment / annual net cash flow

payback period = 180000 / 61857.14

= 2.9 years