Jasper Company has a payback goal of three years on acquisitions of new equipment.A new piece of equipment that costs $450,000 and a five-year life is being considered.Straight-line (SL)depreciation will be used,with zero salvage value.Jasper is subject to a 40% income tax rate.To meet the company's payback goal,the equipment must generate reductions in annual cash operating costs of:

Question

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To meet the payback goal of three years, the equipment must generate enough cash savings to recover the $450,000 cost in three years. The annual depreciation expense is $90,000 ($450,000/5 years). The tax shield from depreciation is $36,000 ($90,000 * 40%). Therefore, the net cash savings needed per year is $150,000 ($450,000/3 years) minus the tax shield of $36,000, which equals $114,000. However, the correct choice is $190,000 because the tax shield was not subtracted correctly in the initial calculation.

Jasper Company Has a Payback Goal of Three Years on Acquisitions