X Company is considering an upgrade to its computer equipment that will cost $8,

Question

X Company is considering an upgrade to its computer equipment that will cost $8,000 but result in smaller operating costs. Estimated annual operating costs are as follows:

If X Company decides to replace the equipment, what is the payback period (in years)?

Present Value of $1.00

Present Value of an Annuity of $1.00

Year no upgrade upgrade    1 $-6,000      $-7,000      2 -8,000      -4,000      3 -8,000      -3,000      4 -8,000      -3,000      5 -6,000      -3,000      6 -5,000      -2,000      7 -4,000      -2,000  

Explanation / Answer

Payback Period = Cost of Project / Annual Cash Inflows Payback Period ignores time value of money Year No upgrade Upgrade Net cash flow Cummualtive cashflow 0                     -         8,000                (8,000)                                   (8,000) 1              6,000       7,000                (1,000)                                   (9,000) 2              8,000       4,000                  4,000                                   (5,000) 3              8,000       3,000                  5,000                                             -   4              8,000       3,000                  5,000                                      5,000 5              6,000       3,000                  3,000                                      8,000 6              5,000       2,000                  3,000                                   11,000 7              4,000       2,000                  2,000                                   13,000 Conclusion: from the above caculation the pay back period is 3 years when the cummulative cashflow showing a Nil balance

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