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 cash flow each year of the equipment's life would be as follows: What is the payback period?

Question

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 cash flow each year of the equipment's life would be as follows:  What is the payback period?

Quizplus · Accepted Answer

To calculate the payback period, we need to find out in which year the cumulative cash inflows will exceed the initial investment. 
Starting with Year 1: 
Cumulative Cash Inflows = $70,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = -$430,000

Year 2: 
Cumulative Cash Inflows = $140,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = -$360,000

Year 3: 
Cumulative Cash Inflows = $210,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = -$290,000

Year 4: 
Cumulative Cash Inflows = $280,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = -$220,000

Year 5: 
Cumulative Cash Inflows = $350,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = -$150,000

Year 6: 
Cumulative Cash Inflows = $420,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = -$80,000

Year 7: 
Cumulative Cash Inflows = $570,000 
Cumulative Investment = $500,000 
Cumulative Net Cash Flow = $70,000

Therefore, the payback period is between Year 5 and Year 6. 
Payback Period = Year 5 + $150,000/$200,000 
Payback Period = 5.97 years