Question

McAlister Products is considering acquiring a manufacturing plant. The purchase price is $ 1,525,000. The owners believe the plant will generate net cash inflows of $ 305,000 annually. It will have to be replaced in seven years. To be​ profitable, the​ investment's payback period must occur before the​ investment's replacement date. Use the payback method to determine whether McAlister Products should purchase this plant.

Answer 1

Answer:

Payback is 5 years. The company should purchase the plant as payback occurs before the replacement date.

Explanation:

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

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

As such:

$Payback=\frac{1,525,000}{305,000}= 5years$

McAlister Products, will consider this machine profitable, and worth investing in if payback  occurs before the​ investment's replacement date. In other words, the company should purchase this plant if payback period is less than 7 years. From the calculation above, payback period is 5 years which is less than 7 years. The company should thus purchase this plant.