MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000. The project will generate after-tax cash flows of $33,100 in Year 1, $31,500 in Year 2, and $31,200 in Year 3. Assume that the firm's proper rate of discount is 10% and that the firm's tax rate is 40%. What is the project's payback?
A) 0.33 years
B) 1.22 years
C) 2.33 years
D) Three years

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the project to recover its initial investment from its cash inflows. Here, the cumulative cash flow at the end of Year 1 is $33,100, at the end of Year 2 is $64,600 ($33,100 + $31,500), and at the end of Year 3 is $95,800 ($64,600 + $31,200). The initial investment of $75,000 is recovered between Year 2 and Year 3. To find the exact payback period: at the end of Year 2, $64,600 has been recovered, leaving $10,400 ($75,000 - $64,600) to be recovered in Year 3. The cash flow in Year 3 is $31,200, so the fraction of the year needed to recover the remaining $10,400 is $10,400 / $31,200 = 0.33 years. Therefore, the total payback period is 2 years + 0.33 years = 2.33 years.

MacHinery Manufacturing Company Is Considering a Three-Year Project That Has