Pique Corporation wants to purchase a new machine for $270,000. Management predi
ID: 2514080 • Letter: P
Question
Pique Corporation wants to purchase a new machine for $270,000. Management predicts that the machine can produce sales of $160,000 each year for the next 4 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $69,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40.00%. Management requires a minimum after-tax rate of return of 10.00% on all investments.
What is the present value payback period, rounded to one-tenth of a year? Use Excel PV in your calculations.
A.3.0
B.N/A cumulative cash flow is always negative
C.4.0
D.6.0
E.5.0
Explanation / Answer
Initial cost of equipment: $270000
Annual cash inflows:
Sales: $160000
Annual cash Outflows:
Expenses -69000
Income Tax
income - 160000
less expenses 69000
less Depreciation 67500
Net Income 23500
Tax On 23500*40% 9400
Non cash expenses:
Depreciation expense: $67500
Step 1: In order to compute the payback period of the equipment, we need to workout the net annual cash inflow by deducting the total of cash outflow from the total of cash inflow associated with the equipment.
Computation of net annual cash inflow:
$160000 – ($69000+9400)
= $81600
Step 2: Now, the amount of investment required to purchase the equipment would be divided by the amount of net annual cash inflow (computed in step 1) to find the payback period of the equipment.
= $270000/$81600
3.3 Years
Payback period is 3.3 years
Note Depreciation is a non-cash expense and has therefore been ignored while calculating the payback period of the project.