Michigan Mattress Company is considering the purchase of land and the construction of a new plant.The land, which would be bought immediately (at t = 0), has a cost of R100,000 and the building, which would be erected at the end of the first year (t = 1), would cost R500,000.It is estimated that the firm's after-tax cash flow will be increased by R100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years.What is the approximate payback period?

Question

Quizplus · Accepted Answer

The payback period is the amount of time it takes for the cash inflows to equal the initial investment.

Initial investment = R100,000 + R500,000 = R600,000

Incremental cash flow starting from year 2 = R100,000
Incremental cash flow in year 3 = R100,000 + 10% of R100,000 = R110,000
Incremental cash flow in year 4 = R110,000 + 10% of R110,000 = R121,000
...
Incremental cash flow in year 11 (end of 10th year) = R259,374.21

To find the payback period, we need to determine in which year the incremental cash flows will equal the initial investment of R600,000.

Year 2 incremental cash flow: R100,000
Year 3 incremental cash flow: R110,000
Year 4 incremental cash flow: R121,000
Year 5 incremental cash flow: R133,100
Year 6 incremental cash flow: R146,410

Therefore, it will take approximately 6 years for the incremental cash flows to equal the initial investment of R600,000.

Michigan Mattress Company Is Considering the Purchase of Land and the Construction