Compute the payback period for each of these two separate investments: 1.) A new

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 $210,000, has a $14,000 salvage value, is expected to last seven years, and will generate an after-tax income of $43,000 per year after straight-line depreciation.

Explanation / Answer

Payback period = cost of investment / annual net cash flow = $260K/$125K = 2.1 years where, Annual after-tax income is $75K, add depreciation of $50K which totals an annual net cash flow of $125K Annual depreciation = $260K - $10k / 5 = $50k 2. A machine costs $190,000, has a $10,000 salvage value, is expected to last nine years, and will generate an after-tax income of $30,000 per year after straight-line depreciation. Payback period = cost of investment / annual net cash flow = $190K / $50K = 3.8 years Where, Annual after-tax income is $30K, add depreciation of $20K which totals $50K Annual depreciation = $190K-$10K / 5 = $20K

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