The management of Zesty Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for Years 1 through 5 are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: The cash payback period for this investment is

Question

The management of Zesty Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for Years 1 through 5 are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation:  The cash payback period for this investment is

Quizplus · Accepted Answer

To calculate the cash payback period, we need to divide the initial investment ($400,000) by the annual cash inflows from the investment until the initial investment is paid off.

Annual cash inflows = Annual net cash flows + Depreciation

Depreciation = Initial investment / Useful life of the machine (Assuming straight-line method, useful life = 5 years)

Depreciation = $400,000 / 5 = $80,000

Year 1 net cash inflow = -$400,000 + $200,000 = -$200,000
Year 2 net cash inflow = -$80,000 + $200,000 = $120,000
Year 3 net cash inflow = $120,000
Year 4 net cash inflow = $120,000
Year 5 net cash inflow = $120,000

Cumulative cash inflow at the end of Year 2 = -$200,000 + $120,000 = -$80,000
Cumulative cash inflow at the end of Year 3 = -$80,000 + $120,000 = $40,000
Cumulative cash inflow at the end of Year 4 = $40,000 + $120,000 = $160,000
Cumulative cash inflow at the end of Year 5 = $160,000 + $120,000 = $280,000

The cash payback period is the time taken to fully recover the initial investment. We can see that the initial investment of $400,000 is recovered at the end of Year 3, when the cumulative cash inflow reaches $40,000. Therefore, the cash payback period is 3 years.

Since the cash payback period is less than the useful life of the machine (5 years), the investment is acceptable.

Therefore, the best choice is D.

The Management of Zesty Corporation Is Considering the Purchase of a New