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Please assist me with the following question:
A company is considering on investing $400000 for a new machinery. The machinery is expected to yield incremental profits over the next five years as follows:
Yr 1 175000
Yr 2 225000
Yr 3 340000
Yr 4 165000
Yr 5 125000Thereafter, no incremental profits are expected and the machinery will be sold. It is company policy to depreciate machinery on straight line basis over the life of the asset. The machinery is expected to have a value of 50000 at the end of year 5.
What is the payback period of the investment for the machinery (nearest 0.1 years)
Your response is highly appreciated. This question requires your immediate attention as I’ll be sitting for my FMA mock exams tomorrow. Thank you.
I believe the payback period is two years as depreciation is not considered as it is a not a cash flow.
175000+225000=400000.The initial outlay is paid back within two years.I initially thought of that, however I was baffled when the answer provided was 1.5 years
Sorry, you do have to consider depreciation as its the incremental profits that are given in the question.
So you have to work out incremental cash flows for each year.
Depreciation per year is 70000 as 400000-50000=350000
350000/5=70000
Depreciation has to be added back to incremental profit to give cash flow each year.
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