Answer:
Payback period = 2.49 years
Break-even time = 3.36 years
Explanation:
a. Calculation of payback period
The payback period can be described as the amount of time it will take a firm recover its cost on a project or an investment.
The payback period can be calculated as follows:
Equipment cost = $107,000
Annual cash flow = $43,000
Payback period = Equipment cost / Annual cash flow = $107,000 / $43,000 = 2.49 years
b. Calculation of break-even time
Note: See the attached excel file for the computation of the cumulative present value of inflow (outflow).
In the attached excel, the present value (PV) factor is calculated using the following formula:
PV factor = 1/(1 + r)^n ............................... (1)
Where;
r = interest rate = 15%
n = a particular year from 1 to 5.
Break even time can be described as the amount of time that is needed for both the discounted cash flows and the initial cost of a project to be equal.
The break-even time is calculated using the following formula:
Break-even time = X + (Y / Z) .................... (2)
X = Last year with a negative cumulative cash flow = 3
Y = Absolute value of cumulative cash flow at the end of period X = $8,821.32
Z = Present value of cash inflow for the period following X = $24,585.39
Break-even time = 3 + ($8,821.32 / $24,585.39) = 3 + 0.36 = 3.36 years
