Question

The Higgins Company has just purchased a piece of equipment at a cost of $120,000. This equipment will reduce operating costs by $40,000 each year for the next eight years. This equipment replaces old equipment which was sold for $8,000 cash. The new equipment has a payback period of:A. 8.0 yearsB. 2.8 yearsC. 10.0 yearsD. 3.0 years

Answer 1

B. 2.8 years

Step-by-step explanation:

Initial investment = -120,000+ 8,000 = -112,000

Yr 1 cash inflow = 40,000, hence net CF = 40,000-112,000 = -72,000

Yr 2 cash inflow = 40,000, hence net CF = 40,000- 72,000 = -32,000

Yr 3 cash inflow = 40,000, hence net CF = 40,000-32,000 = 12,000

Payback period = last year with negative net CF + (absolute net CF that year/ total CF the following year)

= 2 + (32,000/40,000)

= 2 + 0.8

= 2.8 years