Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine will produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $50,000. Quip's combined income tax rate, t, is 40%.

What is the payback period for the new machine (rounded to the nearest one-tenth of a year)? Assume that the after-tax cash inflows occur evenly throughout the year.
A) 2.7 years.
B) 3.0 years.
C) 3.3 years.
D) 3.6 years.
E) 4.2 years.

Question

Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine will produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $50,000. Quip's combined income tax rate, t, is 40%.

What is the payback period for the new machine (rounded to the nearest one-tenth of a year) ? Assume that the after-tax cash inflows occur evenly throughout the year.

What is the payback period for the new machine (rounded to the nearest one-tenth of a year)? Assume that the after-tax cash inflows occur evenly throughout the year.
A) 2.7 years.
B) 3.0 years.
C) 3.3 years.
D) 3.6 years.
E) 4.2 years.

Quizplus · Accepted Answer

The payback period is calculated by dividing the initial investment by the annual after-tax cash inflow. First, calculate the annual depreciation: ($300,000 - $50,000) / 5 years = $50,000 per year. Then, calculate the annual operating income before taxes: $200,000 (sales) - $80,000 (expenses) - $50,000 (depreciation) = $70,000. After-tax operating income is $70,000 * (1 - 0.40) = $42,000. Add back the depreciation (since it's a non-cash expense) to get the annual cash inflow: $42,000 + $50,000 = $92,000. Finally, divide the initial investment by the annual cash inflow: $300,000 / $92,000 ≈ 3.3 years.

Quip Corporation Wants to Purchase a New Machine for $300,000