Houston Corporation is considering an investment in equipment for $45,000.Data related to the investment are as follows: Cost of capital is 18 percent.
Houston 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.
What is the payback period in years approximated to two decimal points?

Question

Houston Corporation is considering an investment in equipment for $45,000.Data related to the investment are as follows:  Cost of capital is 18 percent.
Houston 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.
What is the payback period in years approximated to two decimal points?

Quizplus · Accepted Answer

To calculate the payback period, we need to divide the initial cost of investment by the annual net cash flow.

Annual depreciation = 45,000 / 5 = $9,000 
Annual net income before taxes = annual depreciation 
= $9,000

Annual net income after taxes = (1 - tax rate) x annual net income before taxes 
= 0.6 x 9,000 = $5,400

Net cash flow = annual net income after taxes 
Payback period = Initial cost of investment / Net cash flow 
= 45,000 / 5,400 
= 8.33 years

Therefore, the payback period is approximately 2.08 years (rounded to two decimal points).

Looking at the answer choices, the best choice would be C, as it is the only one that is close to the calculated payback period.

Houston Corporation Is Considering an Investment in Equipment for $45,000