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J Co is considering investing in a new machine costing $18750, payable immediately. The scrap value will be zero, and the machine will be depreciated on a straight line basis.Output would be 1,000 units per year for each of the six years of the machines life. Each unit earns a contribution of $5
Using a discount rate of 8% and assuming that the cash flowa arise at the end of a year, what is the discounted payback period?
Sir my answer was 4 years and 4 month
The correct answer in the revision kit was 5 yearsI don’t understand how that could be the correct answer sir
The question says that the cash flows arise at the ends of years.
Therefore after 4 years and 4 months, no cash flow will have happened for the final 4 months – it is only at the end of the 5th year that the cash arrives.
Oh ok so if we assume in a scenario where the answer was 3 years would that mean the cashflow will arrive at 3 years or 4 years sir?
If the answer came to exactly 3 years then it is 3 years. If the answer came to a bit more than 3 years then the answer would be 4 years. (But only because of the fact that the cash flows were said to arrive at the ends of years.)
Sir I have confusion in this question, there is another requirement which says
A) assuming that the cash flows arise evenly throughout the year, what is the payback period?
Sir as it’s said, depreciation is not a cashflow and we deduct it from the investment, while adding it back to the profit, but the answer specified in the book is different, it just divides $18,750/5000 which output× contribution (profit), I’m confused why aren’t we adding back the depreciated value back to profit? While deducting from the investment value
If the discounted payback period is asked for then you can only assume that cash flows are arrived at the end of years. You cannot be expected to discount for fractions of a year.
If it is the normal payback period then you can do it to the nearest month as I explain in my free lectures.
Contribution does not equal profit. The contribution is after variable costs but not after fixed costs, and depreciation is not a variable cost.
Oh, so if it would be profit instead of contribution, we would add back the depreciated value right sir? And also 18750/5000 is it incorrectly done? Because the answer is 3 years and 9months for the payback period
Yes – if it was profit then you would add back depreciation.
And yes – if it was the basic payback period (not the discounted payback period) then you would do it to the nearest month.
Yes sir it’s the normal payback, the first requirement asks just for payback, second one asks tor discounted payback where cash flows arrives at the end of the year.
Thankyou sir!
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