A company is considering the purchase of a new machine for $128,000. Management predicts that the machine can produce sales of $32,000 each year for the next 8 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $7,500 per year plus depreciation of $10,800 per year. The company's tax rate is 38%. What is the payback period for the new machine?

Question

Quizplus · Accepted Answer

To find the payback period, we need to find the length of time it takes for the cash inflows (sales revenue minus expenses) to recover the initial investment of $128,000.

First, we need to calculate the annual cash inflow:

Annual sales revenue = $32,000 
Annual expenses = $7,500 + $10,800 = $18,300 
Annual cash inflow = $32,000 - $18,300 = $13,700

Next, we calculate the cumulative cash inflows for each year: 
Year 1: $13,700 
Year 2: $27,400 
Year 3: $41,100 
Year 4: $54,800 
Year 5: $68,500 
Year 6: $82,200 
Year 7: $95,900 
Year 8: $109,600

The payback period is the point at which the cumulative cash inflows equal the initial investment of $128,000.

Based on the above calculation, it takes just over 6.63 years to reach this point. Therefore, the best choice is B.

A Company Is Considering the Purchase of a New Machine