Saturn Ltd. wants to automate one of its production processes. The new equipment will cost $180,000. In addition, Saturn will incur installation and testing costs of $5,000 and $8,500 respectively. The expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000. The annual cash savings are estimated at $32,000. The company's required rate of return is 14%. Ignore income taxes. What is the payback period for this investment?
A) 5.63 years
B) 5.78 years
C) 6.05 years
D) 5.26 years
E) The project does not payback.

Question

Quizplus · Accepted Answer

To calculate the payback period, we need to find out how many years it takes to recover the initial investment.

First, we need to determine the annual cash inflow:

Annual cash inflow = Annual cash savings - Annual depreciation
Annual depreciation = (Initial cost - Salvage value) / Useful life
Annual depreciation = ($180,000 - $18,000) / 8 = $21,000

Annual cash inflow = $32,000 - $21,000 = $11,000

Next, we can calculate the payback period:

Payback period = Initial investment / Annual cash inflow
Payback period = ($180,000 + $5,000 + $8,500) / $11,000
Payback period = $193,500 / $11,000
Payback period = 17.59 years

Since the payback period is longer than the expected life of the equipment (8 years), the project does not payback. Therefore, the best choice is E (The project does not payback).