Question

A company with $500,000 in operating assets is considering the purchase of a machine that costs $60,000 and which is expected to reduce operating costs by $15,000 each year. These reductions in cost occur evenly throughout the year. The payback period for this machine in years is closest to (Ignore income taxes.):

Answer 1

Answer:

Payback = 4 years

Explanation:

If a project has equal annual cash-flows, the payback period can be  calculated using the formula:

$Payback=\frac{CostOfMachine}{AnnualCashflows}$

The reduction in operating costs resulting from the purchase of the machine is treated as cash inflows for capital investment decisions. As such, annual cash inflows to be used in the formula above =$15,000 each year.

$Payback=\frac{60,000}{15,000}=4years$

It will take the company 4 years to recover the initial investment.