**I need to know HOW TO SOLVE this problem. Thanks (Ignore income taxes in this

Question

**I need to know HOW TO SOLVE this problem. Thanks

(Ignore income taxes in this problem.) Jarvey Company is studying a project that would have a ten-yeaar life and would require a $450,000 investment in equipment which has no salvage value. The project would provide net operating income each year as follows for the life of the project:

Sales $500,000

Less cash variable expenses 200,000

Equals Contribution Margin 300,000

Less fixed expenses:

Fixed cash expenses $120,000

Depreciation expenses 45,000 195,000

Net operating income $105,000

The company's required rate of return is 12%. What is the payback period for this project?

Explanation / Answer

According to the given information, Net operating income (EBIT) = $105,000 Depreciation = $45,000 Required rate of return = 12% First, we have to calculate the operating cash flows for the first 10 yrs, and then we have to calculate the Payback period. Operating cash flows = EBIT + Depreciation - Taxes In this problem, income taxes are ignored. Hence the effect of tax on cash flows is zero. Substituting the values in the above formula, we get Operating cash flows = $105,000 + $45,000 - $0 = $150,000 Therefore, the operating cash flows for 10yrs is $150,000 The cash flows are even (same) for 10yrs. The formula for calculating the payback period is Payback period = Cost of the investment / Net annual cash flows = $450,000 / $150,000 = 3yrs Therefore, the time to recover the initial investment is 3yrs. Hence the payback period is 3yrs

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