Exercise 10-13B Determining the payback period with uneven cash flows Vienna Sno

Question

Exercise 10-13B Determining the payback period with uneven cash flows Vienna Snowmobile Company is considering whether to invest in a particular new snowmobile model. The model is top-of-the-line equipment for which Vienna expects high demand during the first year it is available for rent. However, as the snowmobile ages, it will become less desirable and its rental revenues are expected to decline. The expected cash inflows and outflows follow: Year Nature of Cash FlowCash Inflow Cash Outflow $70,000 2019 Purchase price 2019 Revenue 2020 Revenue 2021 Revenue 2021 Major overhaul 2022 Revenue 2023 Revenue 2023 Salvage value $40,000 30,000 27,500 10,000 15,000 10,000 8,000 Required a. Determine the payback period using the accumulated cash flows approach. b. Determine the payback period using the average cash flows approach.

Explanation / Answer

The average cash flow for the five years will be (40000+30000+27500-10000+15000+10000+8000)/5 = 24100

Payback period = initiaal cashflow/avg cash flow = 70000/24100= 2.9046 years

year Cash flow Cumulative cash flows 2019 -70000 -70000 2019 40000 -30000 2020 30000 0 2021 27500 27500 2021 -10000 17500 2022 15000 32500 2023 10000 42500 2023 8000 50500 Initial investment = 70000 Payback period is 2 years Assuming that machine is bought at the beginning of 2019 and revenues are calculated at the year end

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