Mystery Co.is considering purchasing a new piece of equipment that will cost $600,000.The equipment has an estimated useful life of 8 years and no salvage value.The equipment will produce cash inflows of $215,000 per year and net income of $90,000 per year.Mystery requires a 10% rate of return.What is the payback period for this equipment?

Question

Quizplus · Accepted Answer

To calculate the payback period, we need to determine how many years it will take for the cash inflows to equal the initial investment.
Year 1 cash inflow: $215,000
Initial investment: $600,000
$600,000 - $215,000 = $385,000
Year 2 cash inflow: $215,000
$385,000 - $215,000 = $170,000
Year 3 cash inflow: $215,000
$170,000 - $215,000 = -$45,000
The payback period is 2 years plus the remaining investment divided by the cash inflows for year 3:
2 + ($45,000/$215,000) = 2.79 years
Since the payback period is less than the equipment's estimated useful life of 8 years and the project meets the company's required rate of return of 10%, the equipment should be purchased.