1.) A new operating system for an existing machine is expected to cost $250,000

Question

1.) A new operating system for an existing machine is expected to cost $250,000 and have a useful life of four years. The system yields an incremental after-tax income of $72,115 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000. What is the payback period? 2.) A machine costs $180,000, has a $13,000 salvage value, is expected to last eleven years, and will generate an after-tax income of $39,000 per year after straight-line depreciation. What is the payback period?

Explanation / Answer

Depreciation = (Cost of the asset - salvage value)/ Life of the asset       = (250,000 - 10,000)/ 4       = 60,000 Year Net Cash flows After-tax income Depreciation Salvage value Net Cash flows (income + Dep. + Salvage Value) Cummulative cash flows 0 -250,000 -250,000 1 72,115 60,000 132,115 132,115 2 72,115 60,000 132,115 264,115 3 72,115 60,000 132,115 396,115 4 72,115 60,000 10,000 142.115 538,115 Payback period = 1 year + (250,000 -132,115) / 132,115 = 1year + 0.89    = 1.89 years

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