Melancholy Company is considering the purchase of production equipment that costs $800,000. The equipment is expected to generate an annual cash flow of $250,000 and have a useful life of five years with no salvage value. The firm's cost of capital is 12 percent. The company uses the straight-line method of depreciation with no mid-year convention. There are no income taxes. The payback period in years for the project is

Question

Quizplus · Accepted Answer

The payback period is the time needed to recover the initial investment. It is calculated by dividing the initial investment by the annual cash flows generated by the project.

In this case, the initial investment is $800,000, and the annual cash flow is $250,000. Therefore, the payback period is:

Payback period = $800,000 / $250,000 = 3.20 years

Since the payback period is less than the useful life of the equipment (5 years), the project is considered acceptable.

Melancholy Company Is Considering the Purchase of Production Equipment That