Quiz 26: Capital Budgeting

Business

Payback period: It is the period in which the initial investment will be received back. In other words, it is the period in which the initial investment will be covered through the annual cash inflows. The following is the formula to compute the payback period. img Use the above formula to compute the payback period as below: img Hence, the payback period is 5.03 years. From the above computation it is clear that with the annual cash inflows of $28,000 per year and depreciation of $6,800 (being non-cash expense), the amount invested can be attained back in approximately 5 years.

a. Net present value of proposal, discounted at an annual rate of 15%: img b. The cost of the laser printer is $1,300,000, not $2,500,000as Adams suggests. Adams is including the $1,200,000 after tax loss on the sale of the existing equipment as part of the cost of the laser printer. This $1,200,000 is part of the cost of the old equipment, not of the laser printer. The $1,200,000 is a sunk cost, that is, it has already been incurred and exists regardless of whether the existing equipment is sold or continued in use. The cost of the laser printer consists only of the $1,300,000 price, which must be paid to purchase it.

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