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A Vehicle Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art robotic machine. They...

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Accounting

  1. A Vehicle Corporation is considering replacing atechnologically obsolete machine with a new state-of-the-artrobotic machine. They have compiled the following data for the newmachine:

Cost of new machineneeded                                                $150,000

Annual net cashinflows                                                          $40,000

Salvage value of the machine in 10years .$20,000

Useful life of themachine                                                        10years

Required rate ofreturn                                                                   10%

The company uses straight-line depreciation on allequipment.

a. What is the payback period for this machine? Ignorethe impact of income taxes.

b. How is the payback period used in evaluating potentialinvestments?

Answer & Explanation Solved by verified expert
3.6 Ratings (403 Votes)

Payback period
Time Amount Cumulative
                                                                       -          (150,000.00)        (150,000.00)
                                                                  1.00            40,000.00        (110,000.00)
                                                                  2.00            40,000.00          (70,000.00)
                                                                  3.00            40,000.00          (30,000.00)
                                                                  4.00            40,000.00            10,000.00
                                                                  5.00            40,000.00            50,000.00
                                                                  6.00            40,000.00            90,000.00
                                                                  7.00            40,000.00          130,000.00
                                                                  8.00            40,000.00          170,000.00
                                                                  9.00            40,000.00          210,000.00
                                                                10.00            60,000.00          270,000.00
Payback period = 3 + 30,000/40,000
Payback period = 3 + .75 Years
Payback period = 3.75 Years
The payback period is an effective measure of investment risk. It is widely used when liquidity is an important criteria to choose a project.
Since company is able to recover its cash outflows in the fourth year therefore company should go ahead with the proposal

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