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Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
-The payback period for the investment in equipment is closest to:

Question

[The following information applies to the questions displayed below.]
Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
  All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
-The payback period for the investment in equipment is closest to:

Quizplus · Accepted Answer

To calculate the payback period, we need to find the number of years it will take for the company to recover the initial investment of $650,000. We can calculate the annual cash inflows by subtracting the annual expenses (excluding depreciation) from the annual revenue. 
Year 1: $400,000 - $200,000 = $200,000
Year 2: $400,000 - $200,000 = $200,000
Year 3: $400,000 - $200,000 = $200,000
Year 4: $400,000 - $200,000 = $200,000
Year 5: $400,000 - $200,000 = $200,000

To calculate the cumulative cash inflows, we add up the annual cash inflows until they equal the initial investment.

Year 1: $200,000 
Year 2: $400,000 
Year 3: $600,000 
Year 4: $800,000 
Year 5: $1,000,000

The payback period is between Year 4 and Year 5, so the best answer is D) 2.8 years.

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