Question

A company with $780,000 in operating assets is considering the purchase of a machine that costs $84,000 and which is expected to reduce operating costs by $16,000 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 = 5.25 years

Explanation:

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

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

The question does not make specific reference to cash-flows from the project, but the reduction in operating costs every year resulting from the acquisition of this machine is treated as an increase in net cashflows before taxes for the company, and as such will be used as the cash-flows for capital investment analysis.

As such:

$Payback=\frac{84000}{16000}=5.25years$