The management of Zesty Corporation is considering the purchase of a new machine costing $400,000.The company's desired rate of return is 10%.The present value factors for $1 at compound interest of 10% for Years 1 through 5 are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively.In addition to the foregoing information, use the following data in determining the acceptability in this situation: The cash payback period for this investment is

Question

The management of Zesty Corporation is considering the purchase of a new machine costing $400,000.The company's desired rate of return is 10%.The present value factors for $1 at compound interest of 10% for Years 1 through 5 are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively.In addition to the foregoing information, use the following data in determining the acceptability in this situation:  The cash payback period for this investment is

Quizplus · Accepted Answer

The cash payback period is the amount of time it takes for the company to recover the initial investment amount through the cash inflows generated by the new machine. 
To calculate the cash inflows for each year, we need to multiply the annual cash inflow by the present value factor for that year. 
Assuming that the machine generates an annual cash inflow of $100,000, the cash inflows for Years 1 through 5 are $90,900, $82,600, $75,100, $68,300, and $62,100, respectively. 
To determine the cash payback period, we add up the cash inflows until we reach the initial investment amount:

$90,900 + $82,600 + $75,100 + $68,300 + $62,100 = $379,000

We can see that the initial investment amount of $400,000 is not fully recovered by the end of Year 4, but it is recovered by the end of Year 5. Therefore, the cash payback period for this investment is 5 years.

However, the management's desired rate of return is 10%. To determine whether this investment meets the desired rate of return, we can calculate the net present value (NPV) of the cash inflows.

NPV = (Annual cash inflow x Present value factor) + (Annual cash inflow x Present value factor) + ... - Initial investment

NPV = ($100,000 x 0.909) + ($100,000 x 0.826) + ($100,000 x 0.751) + ($100,000 x 0.683) + ($100,000 x 0.621) - $400,000

NPV = $90,900 + $82,600 + $75,100 + $68,300 + $62,100 - $400,000

NPV = $79,000

Since the NPV is positive, the investment meets the desired rate of return and is therefore acceptable.

Therefore, the best choice is option D, 3 years. However, this answer assumes that the company is only concerned with the cash payback period and not the desired rate of return. If the desired rate of return is also a factor, then the investment is acceptable but will take 5 years to fully recover the initial investment amount.

The Management of Zesty Corporation Is Considering the Purchase of a New