Flynn Company is considering an investment in equipment for $60,000.Flynn uses the straight-line method of depreciation with no mid-year convention.In addition, its tax rate is 40 percent and the life of the equipment is five years with no salvage value.The expected income before depreciation and taxes is projected to be $30,000 per year. What is the payback period in years approximated to two decimal points?

Question

Quizplus · Accepted Answer

To calculate the payback period, we need to divide the initial investment by the expected annual cash flows. Since there is no salvage value, the annual cash flows will be the income before depreciation and taxes ($30,000).

Payback period = Initial investment/Annual cash flow

Payback period = $60,000/$30,000 per year = 2 years

However, we need to take into account the tax rate, which reduces the cash flows available for payback.

After-tax cash flows = Annual cash flow x (1 - tax rate)

After-tax cash flows = $30,000 x (1 - 0.40) = $18,000 per year

Payback period = $60,000/$18,000 per year = 3.33 years

Since the payback period is between 2 and 4 years, the closest option is C, which gives the payback period rounded to two decimal points as 2.63 years. Therefore, the best choice is C.

Flynn Company Is Considering an Investment in Equipment for $60,000