Question

XYZ is considering two proposed machinery investments. Proposals A and B each cost $600,000, have 6-year lives, and have expected total cash flows of $750,000. Proposal A is expected to provide equal annual net cash flows of $125,000 while the net cash flows for Proposal B are as follows: Year 1 $250,000 Year 2 $200,000 Year 3 $150,000 Year 4 $ 75,000 Year 5 $ 50,000 Year 6 $ 25,000 Determine the cash payback period for Proposal A and B. Show all calculations. Rounds answers to 1 decimal place.

Answer 1

Answer:

Payback period for Proposal A =  4.8 years

Payback period for Proposal B =  3 years

Explanation:

Calculation of Payback period for Proposal A:

Year Investment Net Annual Cash Flow  

0              $600,000                $125,000  

1                                                 $125,000

2                                                $125,000

3                                                $125,000

4                                                $125,000

5                                                $125,000

6                                                $125,000

Cash Payback period = Cost of Capital investment/Net Annual cash flow

Cash Payback period = $600,000/$125,000

Cash Payback period =  4.8 years

Calculation of Payback period for Proposal B:

Year  Investment   Net Annual Cash Flow   Cumulative Net Cash Flows

0       $600,000              $250,000                      $250,000

1                                       $200,000                       $450,000

2                                      $150,000                        $600,000

3                                      $75,000                          $675,000

4                                      $50,000                          $725,000

5                                      $25,000                          $750,000

6

The Cumulative net cash flow of $600,000 is equal to investment cost of $600,000 for 3 years. So, payback period for proposal B is 3 years.