Cardinal Company is considering a project that would require a $2,810,000 invest
ID: 2479504 • Letter: C
Question
Cardinal Company is considering a project that would require a $2,810,000 investment in equipment with a useful life of five years. At the end of five years, the project would terminate and the equipment would be sold for its salvage value of $500,000. The company’s discount rate is 16%. The project would provide net operating income each year as follows:
What is the project’s payback period? (Round your answer to 2 decimal places.)
Cardinal Company is considering a project that would require a $2,810,000 investment in equipment with a useful life of five years. At the end of five years, the project would terminate and the equipment would be sold for its salvage value of $500,000. The company’s discount rate is 16%. The project would provide net operating income each year as follows:
Explanation / Answer
Solution:
Payback period is the length of time whithin which initial investments are returned back to the company.
Payback Period does not consider the time value of money concept.
Payback Period considers Cash Flows.
Cash Flows = Net Profit after tax and depreciation + Depreciation (Non cash item)
Here tax is not given, hence Net Operation Expenses are considered while calculating Cash Flows from Investments
Annual Cash Inflows = Net operating income + Depreciation = 482,000 + 462,000 = $944,000
Since the annual cash inflows are uniform (same) in each year, the payback period is calculated by using following formula:
Payback Period (in case of uniform cash inflow) = Initial Investment Cost / Annual Cash Inflows
= $2,810,000 / $944,000
= 2.98 years
Note --- Payback Period does not consider Salvange Value of investment at the end of year.