Question

Using payback to make capital investment decisions

Answer 1

Answer: Henry should purchase this plant as it pays back in less than the 6 years it will have to be replaced in.

Payback period = 3.7 years

Explanation:

Payback period is a capital budgeting strategy that shows how long it will take for cash inflow to pay off the original investment.

The formula is;

= Year before payback + Cashflow remaining till payback/ Cash inflow in year of Payback

Year before payback

= 1,200,000/ 325,000

= 3.69

= 3 years

Cashflow remaining

= 1,2000,000 - (325,000 * 3)

= $225,000

= Year before payback + Cashflow remaining till payback/ Cash inflow in year of Payback

= 3 + 225,000/325,000

= 3.69

= 3.7 years