Joyous Corporation is considering an investment in equipment for $25,000. Data related to the investment are as follows: $$\begin{array}{l}\begin{array} { c c }
&\text { Cash Flow before }\
\text { Year } & \text { Depreciation and Taxes } \
1 & \$ 12,500 \
2 & 12,500 \
3 & 12,500 \
4 & 12,500
\end{array}
\end{array}$$ Joyous 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 four years with no salvage value. Cost of capital is 12 percent. What is the payback period in years approximated to two decimal points?

Question

Joyous Corporation is considering an investment in equipment for $25,000. Data related to the investment are as follows: $$\begin{array}{l}\begin{array} { c c } 
&\text { Cash Flow before }\
\text { Year } & \text { Depreciation and Taxes } \
1 & \$ 12,500 \
2 & 12,500 \
3 & 12,500 \
4 & 12,500
\end{array}
\end{array}$$ Joyous 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 four years with no salvage value. Cost of capital is 12 percent. What is the payback period in years approximated to two decimal points?

Quizplus · Accepted Answer

The payback period is the time it takes for the cash flows to cover the initial investment. Here, the equipment costs $25,000, and the annual cash flow before depreciation and taxes is $12,500. Since depreciation ($25,000/4 = $6,250 per year) does not affect cash flow and taxes are not considered in the payback period calculation, the annual cash inflow remains $12,500. Thus, it takes 2 years to recover $25,000 ($12,500 per year), resulting in a payback period of 2.00 years, not 2.50. The correct answer should be A, not B, based on the calculation mistake in the explanation provided.

Joyous Corporation Is Considering an Investment in Equipment for $25,000