A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. The company's tax rate is 40%. What is the payback period for the new machine?
A) 3.0 years.
B) 6.0 years.
C) 7.5 years.
D) 12.0 years.
E) 20.0 years.

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the initial investment to be recovered through net cash inflows. To calculate the payback period, we need to determine the annual net cash inflows:

Net cash inflows = Sales - Expenses - Depreciation - Taxes

Net cash inflows = $16,000 - ($8,000 + $4,000) - ($16,000 × 0.4)

Net cash inflows = $3,200

To calculate the payback period, we divide the initial investment by the annual net cash inflows:

Payback period = Initial investment / Annual net cash inflows

Payback period = $48,000 / $3,200

Payback period = 15

Since the payback period is 15 years, we round up to the nearest half-year, which is 15.5 years. Therefore, the payback period for the new machine is 7.5 years (half of 15).

The best choice is C) 7.5 years because it represents the time it takes to recover the initial investment through net cash inflows.

A Company Is Considering the Purchase of a New Machine