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

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.

Explanation / Answer

a)

given data

machine cost = 240000

estimated life = 6 years

salvage value = 9000

after tax income = 69230

calculation of annual cash flow :

working note 1:

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

= (240000 - 9000) /6

= 38500

COMPUTATION OF PAYBACK PERIOD :

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 :

CALCULATION OF PAYBACK PERIOD :

payback period = 180000 / 61857.14

= 2.9 years

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