Cowell Corporation is considering an investment in new equipment costing $160,000. The equipment will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash inflows of $40,000 the first year, $35,000 the second year, and $82,000 every year thereafter until the fifth year. What is the payback period for this investment? The equipment has no residual value.

Question

Quizplus · Accepted Answer

The payback period is the amount of time it takes to recoup the initial investment. To calculate the payback period, we need to determine how long it takes for the cumulative net cash inflows to equal the initial investment.

Year 1: $40,000
Year 2: $35,000
Year 3: $82,000
Year 4: $82,000
Year 5: $82,000

To determine the payback period, we need to add the net cash inflows each year until we reach the initial investment of $160,000.

Year 1: $40,000 (Cumulative cash inflow: $40,000)
Year 2: $35,000 (Cumulative cash inflow: $75,000)
Year 3: $82,000 (Cumulative cash inflow: $157,000)
Year 4: $82,000 (Cumulative cash inflow: $239,000)
Year 5: $82,000 (Cumulative cash inflow: $321,000)

The payback period occurs in Year 3, when the cumulative cash inflows reach $160,000. To find out how long it takes to reach Year 3, we use the following formula:

Payback Period = Number of Years Before Full Recovery + (Unrecovered Cost at Start of Year / Net Cash Inflow in Year)

Number of Years Before Full Recovery = 2 (because full recovery occurs in Year 3)
Unrecovered Cost at Start of Year 3 = $160,000 - $157,000 (cumulative cash flow at the end of Year 2) = $3,000
Net Cash Inflow in Year 3 = $82,000

Payback Period = 2 + ($3,000 / $82,000) = 2.0366 years, or approximately 3.04 years.

Therefore, the best choice is D) 3.04 years.

Cowell Corporation Is Considering an Investment in New Equipment Costing