Question

The management of Lanzilotta Corporation is considering a project that would require an investment of $225,000 and would last for 6 years. The annual net operating income from the project would be $115,000, which includes depreciation of $32,000. The scrap value of the project's assets at the end of the project would be $19,300. The cash inflows occur evenly throughout the year. The payback period of the project is closest to

Answer 1

Answer:

Payback =1.53 years

Explanation:

The  annual cash-flow figure that is to be used in this calculation should not include depreciation as depreciation is a non-cash item. Net operating income from the project is $115,000 and to get to annual cash-flows, depreciation should be added back.

Annual cash-flows for each of the 6 years would therefore be:

$115,000+ 32,000= 147,000$

The scrap value would be expected at the end of the project i.e end of year 6.

Year  Cash-flow   Balance

0    (225,000)         (225,000)

1    147,000              (78,000)

2    147,000               69,000  

By end of year 2, the company has already recovered the $225,000 initial investment as seen through the positive cumulative balance

Payback = Years With Negative Cumulative Cash-flow Balance + $\frac{-LastNegativeBalance}{CashInflowfollowingYear}$

$=1+\frac{78,000}{147,000} =1.53years$