Question

First Choice Carpets is considering purchasing new weaving equipment costing $ 734 comma 000. The​ company's management has estimated that the equipment will generate cash inflows as​ follows: Year 1 $ 214 comma 000 2 214 comma 000 3 254 comma 000 4 254 comma 000 5 154 comma 000 Considering the residual value is​ zero, calculate the payback period.​ (Round your answer to two decimal​ places.)

Answer 1

Answer: 3.20 years

Explanation:

The Payback Period is a financial evaluation technique for the viability of projects by checking how long it will take for a project to pay back it's Initial cost of capital.

The above weaving machine cost $734,000 and will generate cash for 5 years.

In the first 3 years it will generate,

= 214,000 + 214,000 + 254,000

= $682,000

You can tell that the Machine will have paid off by the fourth year judging by how much is left to payback.

However, the exact period is needed. You can get that by dividing the amount remaining by the Cashflow for the year in which it is to be completed. This way you can see the proportion of time it will take for the current year to reach the desired sum.

The Cashflow for Year 4 is $254,000.

= (Initial investment - Amount from Year before Payback Year) / Cashflow in Payback Year

= (734,000 - 682,000) / 254,000

= 52,000/ 254,000

= 0.20

It will take 0.20 of Year 4 to payback the amount fully.

That means that the total Payback Period is,

= 3 years + 0.20

= 3.2 years