A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual cash inflows from this investment are $36,000 (year 1), $30,000 (year 2), $18,000 (year 3), $12,000 (year 4) and $6,000 (year 5). The payback period is:
A) 4.50 years.
B) 4.25 years.
C) 3.50 years.
D) 3.00 years.
E) 2.50 years.

Question

Quizplus · Accepted Answer

To calculate the payback period, we need to determine how long it will take for the expected cash inflows to equal the initial investment.

Year 1: $36,000
Year 2: $30,000
Year 3: $18,000
Year 4: $12,000
Year 5: $6,000
Total cash inflows: $102,000

To determine the payback period, we subtract each year's cash inflow from the initial investment until we reach a positive cash flow.

Year 1: $90,000 - $36,000 = $54,000
Year 2: $54,000 - $30,000 = $24,000
Year 3: $24,000 - $18,000 = $6,000
Payback period = 2 years + ($6,000 / $12,000) = 2.5 years

Therefore, the best choice is C, 3.50 years.

A Company Is Considering the Purchase of a New Piece