Question

Assume that a company buys a new machine for $220,000 that has a useful life of five years and a $20,000 salvage value. The new machine will replace an old machine that can be sold for a salvage value of $10,000. The machine will generate incremental contribution margin of $37,500 per year. The only fixed expense associated with the new machine is its annual depreciation of $40,000 per year. What is the payback period for this investment

Answer 1

• Payback period of investment- In case of capital budgeting, it refers to the amount of time taken place to recover the amount or cost of investment.
• Initial cost of investment = Amount invested – Value of salvage sold

                                                 = $ 220000 – 10000

                                                 = $ 210,000

• Annual Cash inflow = Contribution margin = $ 52500

• Payback period = Initial cost of investment /Annual cash inflow

                                     =$210000 / 52500

                                     = 4.0 years

• Answer = 4.0 years

Hence, in four years pay back period for this investment will take place

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