If an asset cost $270000 and is expected to have a $60000 salvage value at the end of its twelve-year life and generates annual net cash inflows of $40000 each year the cash payback period is
A) 2.7 years.
B) 8.25 years.
C) 6.75 years.
D) 5.25 years.

Question

Quizplus · Accepted Answer

The cash payback period is the amount of time required to recover the initial cost of an investment. To calculate the cash payback period, we need to determine how many years it will take for the total net cash inflows to equal the initial cost of the asset.

Initial cost = $270,000
Salvage value = $60,000
Total cash inflows per year = $40,000
Net cash inflows per year = $40,000 - ($270,000 - $60,000) / 12 = $13,000

To determine the cash payback period, we divide the initial cost by the net cash inflows per year:

Cash payback period = $270,000 / $13,000 = 20.77 years

Since the cash payback period is greater than the expected life of the asset (12 years), we need to adjust the calculation. We can determine the year in which the cumulative net cash inflows equal the initial cost of the asset:

Year 1: $13,000
Year 2: $13,000 x 2 = $26,000
Year 3: $13,000 x 3 = $39,000
Year 4: $13,000 x 4 = $52,000
Year 5: $13,000 x 5 = $65,000
Year 6: $13,000 x 6 = $78,000

We can see that the cumulative net cash inflows will equal the initial cost of the asset in year 6. Therefore, the cash payback period is 6 years and 9 months or 6.75 years. The best choice is C.

If an Asset Cost $270000 and Is Expected to Have