Milagros Company is considering an investment in equipment for $60,000. Milagros uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent and the life of the equipment is five years with no salvage value. The expected income before depreciation and taxes is projected to be $30,000 per year. What is the payback period in years approximated to two decimal points?

Question

Quizplus · Accepted Answer

To calculate the payback period, we need to divide the initial investment by the expected annual cash inflow.

First, we need to calculate the annual depreciation expense using the straight-line method:

Annual depreciation = (Cost of equipment - Salvage value) / Useful life
Annual depreciation = ($60,000 - $0) / 5
Annual depreciation = $12,000

Next, we need to calculate the after-tax cash inflow per year:

Income before depreciation and taxes = $30,000
Depreciation expense = $12,000
Taxable income = $18,000
Taxes (40%) = $7,200
Net income after taxes = $22,800
Add back depreciation = $12,000
After-tax cash inflow per year = $34,800

Now we can calculate the payback period:

Payback period = Initial investment / After-tax cash inflow per year
Payback period = $60,000 / $34,800
Payback period = 1.7241 years

Rounding to two decimal points, the answer is 2.63 years. Therefore, the best choice is B.

Milagros Company Is Considering an Investment in Equipment for $60,000