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A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life.If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000.The straight-line method of depreciation would be used.
-The cash payback period on the equipment is

Question

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A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life.If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000.The straight-line method of depreciation would be used.
-The cash payback period on the equipment is

Quizplus · Accepted Answer

Cash payback period = Initial investment / Annual net cash inflow 
Annual net cash inflow = Annual revenues - Annual operating expenses exclusive of depreciation expense = $125,000 
Depreciation expense = (Cost - Salvage value) / Useful life = ($400,000 - $0) / 5 = $80,000 
Hence, the annual net cash inflow after depreciation would be $205,000. 
Cash payback period = $400,000 / $205,000 = 1.95 years, rounded up to 2 years. 
Therefore, the correct answer is (C) 3.2 years.

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