Paramount Company is considering purchasing new equipment costing $708,000.The company's management has estimated that the equipment will generate cash flows as follows:
$$\begin{array} { | r|r | }
\hline \text { Year } 1 &\$ 202,000 \
\hline 2&202,000 \
\hline 3&254,000 \
\hline 4&254,000 \
\hline 5&150,000 \
\hline
\end{array}$$
Residual value is zero.What is the payback period?

Question

Paramount Company is considering purchasing new equipment costing $708,000.The company's management has estimated that the equipment will generate cash flows as follows:
$$\begin{array} { | r|r | } 
\hline \text { Year } 1 &\$ 202,000 \
\hline 2&202,000 \
\hline 3&254,000 \
\hline 4&254,000 \
\hline 5&150,000 \
\hline
\end{array}$$
Residual value is zero.What is the payback period?

Quizplus · Accepted Answer

To calculate the payback period, we need to add up the cash flows until we reach the initial investment of $708,000. 
Year 1: $200,000
Year 2: $300,000
Year 3: $400,000
Year 4: -$608,000 (initial investment of $708,000 minus the accumulated cash flows of $100,000)
Therefore, the payback period is 3 years + ($100,000 ÷ $400,000) = 3.25 or 3.2 years. 
Therefore, the best choice is C.

Paramount Company Is Considering Purchasing New Equipment Costing $708,000 Residual Value Is Zero