Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

The payback period in years (rounded to the nearest 10th of a year) for this proposed investment is (assume that the after-tax cash inflows occur evenly throughout the year):
A) 2.5 years.
B) 3.0 years.
C) 3.5 years.
D) 4.3 years.
E) 4.5 years.

Question

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

The payback period in years (rounded to the nearest 10th of a year) for this proposed investment is (assume that the after-tax cash inflows occur evenly throughout the year) :

The payback period in years (rounded to the nearest 10th of a year) for this proposed investment is (assume that the after-tax cash inflows occur evenly throughout the year):
A) 2.5 years.
B) 3.0 years.
C) 3.5 years.
D) 4.3 years.
E) 4.5 years.

Quizplus · Accepted Answer

To calculate the payback period, we need to determine the number of years it will take for the after-tax cash inflows to recover the initial investment of $45,000.

Year 1: $18,000 after-tax cash inflow
Year 2: $15,000 after-tax cash inflow
Year 3: $9,000 after-tax cash inflow
Year 4: $6,000 after-tax cash inflow
Year 5: $3,000 after-tax cash inflow

Total cash inflows = $51,000 (18,000 + 15,000 + 9,000 + 6,000 + 3,000)
Payback period = Initial investment / Annual cash inflow = $45,000 / $12,750 (average annual cash inflow for years 1-5)
Payback period = 3.53 years (rounded to the nearest 10th of a year)

Therefore, the best choice is (C) 3.5 years.

Brandon Company Is Contemplating the Purchase of a New Piece