Question

Compute the payback period for each of these two separate investments:

Answer 1

Answer:

1.

2.2 years

2.

3.6 years

Explanation:

Payback period is the time in which a project returns back the initial investment in the form of net cash flow. For this purpose we use the net cash flows to calculate the payback.

1.

to calculate the net cash flow we need to adjust the depreciation in incremental after tax income.

Depreciation = ( $520,000 - $10,000 ) / 6 = $85,000

Add this depreciation in the depreciation in incremental after tax income.

Net Cash flow = $150,000 + $85,000 = $235,000

Payback Period = Initial Investment  / Incremental net cash flow each year

Payback Period = $520,000 / $235,000 = 2.2 years

2.

to calculate the net cash flow we need to adjust the depreciation in incremental after tax income.

Depreciation = ( $380,000 - $20,000 ) / 8 = $45,000

Add this depreciation in the depreciation in incremental after tax income.

Net Cash flow = $60,000 + $45,000 = $105,000

Payback Period = Initial Investment  / Incremental net cash flow each year

Payback Period = $380,000 / $105,000 = 3.6 years

Answer 2

Answer:

The payback period is the time that a project needs to recover its initial investment.

1) initial investment = -$520,000

salvage value = $10,000

depreciation per year = $510,000 / 6 years = $85,000

incremental cash flow = $150,000 + $85,000 = $235,000

payback period = $520,000 / $235,000 = 2.212 years or 2 years, 2 months and 17 days.

2) initial investment = -$380,000

salvage value = $20,000

depreciation per year = $320,000 / 8 years = $40,000

incremental cash flow = $60,000 + $40,000 = $100,000

payback period = $380,000 / $100,000 = 3.8 years or 3 years, 9 months and 18 days.