Exercise 25-5 Payback period computation; even cash flows P1 Compute the payback

Question

Exercise 25-5 Payback period computation; even cash flows P1 Compute the payback period for each of these two separate investments (rouad the payback period to two decimals) a. A new operating system for an existing machine is expected to cost $520,000 and have a useful life of six years. The system yields an incremental after-tax income of $150,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10.000. b. A machine costs $380,000, has a $20,000 salvage value, is expected to last eight years, and will gener ate an after-tax income of $60,000 per year after straight-line depreciation. Exercise 25-6 Net present value P3 Refer to the information in Exercise 25-5. Assume the company requires a 10% rate of return on its invest- ments. Compute the net present value of each potential investment. (Round to the nearest dollar.)

Explanation / Answer

Payback period = Cost of investment / Annual net cash flows 1 Cost of investment = $       5,20,000 Annual net cash flows = annual cash flows - Salvage value = $1,50,000 - $10,000 = $       1,40,000 Payback period = $5,20,000 / $1,40,000 = 3.7 years 2 Cost of investment = $       3,80,000 Annual net cash flows = annual cash flows - Salvage value = $60,000 - $20,000 = $           40,000 Payback period = $3,80,000 / $40,000 = 9.5 years

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