Question

Co. is considering acquiring a manufacturing plant. The purchase price is $ 1 comma 100 comma 000. The owners believe the plant will generate net cash inflows of $ 314 comma 000 annually. It will have to be replaced in six years. Use the payback method to determine whether Cole should purchase this plant. Round to one decimal place.

Answer 1

Answer:

Payback period = 3 years 6 months

Plant shall be accepted.

Explanation:

Payback period refers to the term of period in which the cost of the asset will be recovered through the revenues generated via that asset.

If payback period is less than the expected life of asset the project or asset shall be accepted and invested in.

In the given case,

Purchase price of asset = $1,100,000

Cash generated each year = $314,000

Thus, payback period = $\frac{1,100,000}{314,000} = 3.503$

that means 3 years and 12 $\times$ 0.503 = 6.036 months

This is not the discounted payback period.

Here discount rate is not provided, also the life of plant is expected to be 6 years since payback is less that is 3 years and 6 months the purchase of plant offer shall be taken.

Correct answer

Payback period = 3 years 6 months

Plant shall be accepted.