Patterson Corp is considering the purchase of a new piece of equipment,which would have an initial cost of $500,000,a 7 year life,and $150,000 salvage value.The increase in net income each year of the equipment's life would be as follows: What is the payback period?

Question

Quizplus · Accepted Answer

To calculate the payback period, we need to determine the period of time required for the net income to recoup the initial investment cost.

Year 1: $55,000
Year 2: $70,000
Year 3: $85,000
Year 4: $100,000
Year 5: $120,000
Year 6: $130,000
Year 7: $150,000 + $150,000 salvage value = $300,000

To determine the payback period, we add up the net income for each year until the total equals the initial investment cost:
Year 1: $55,000 ($500,000 - $55,000 = $445,000 remaining)
Year 2: $70,000 ($445,000 - $70,000 = $375,000 remaining)
Year 3: $85,000 ($375,000 - $85,000 = $290,000 remaining)
Year 4: $100,000 ($290,000 - $100,000 = $190,000 remaining)
Year 5: $120,000 ($190,000 - $120,000 = $70,000 remaining)
Year 6: $130,000 ($70,000 - $130,000 = -$60,000 remaining)
Therefore, the payback period is between 5 and 6 years, and we can calculate the exact amount:
Payback period = 5 + ($70,000 / $130,000) = 5.54 years.
The closest answer is A) 3.55 years. Therefore, it is not the best choice, and the company should not invest in the equipment if a payback period of less than 6 years is required.

Patterson Corp Is Considering the Purchase of a New Piece