Question

Thornton Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $13,770,000; it will enable the company to increase its annual cash inflow by $5,100,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $27,900,000; it will enable the company to increase annual cash flow by $9,300,000 per year. This plane has an eight-year useful life and a zero salvage value.

Required

Determine the payback period for each investment alternative and identify the alternative Thornton should accept if the decision is based on the payback approach. (Round your answers to 1 decimal place.)

Answer 1

The correct answer for first plane is 2.7 years and for second plane is 3 years and first plane should be accepted.

Step-by-step explanation:

According to the scenario, the computation of the given data are as follows:

Payback period = Cost of first airplane ÷ Annual cash inflow

First plane cost = $13,770,000

Cash flow = $5,100,000

So, Payback period for first plane = $13,770,000 ÷ $5,100,000

= 2.7 years

Second plane cost = $27,900,000

Cash flow = $9,300,000

So, Payback period for second plane = $27,900,000 ÷ $9,300,000

= 3 years

First plane should be accepted as it has less payback period.