Jasper Company has a payback goal of 3 years on new equipment acquisitions. A new sorter is being evaluated that costs $450,000 and has a 5-year life. Straight-line depreciation will be used; no salvage is anticipated. Jasper is subject to a 40% income tax rate. To meet the company's payback goal, the sorter must generate reductions in annual cash operating costs of
Answer(s): D
Given a periodic constant cash flow, the payback period is calculated by dividing cost by the annual cash inflows, or cash savings. To achieve a payback period of 3 years, the annual increment in net cash inflow generated by the investment must be $150,000 ($450,000 ÷ 3-year targeted payback period). This amount equals the total reduction in cash operating costs minus related taxes. Depreciation is $90,000 ($450,000 ÷ 5 years). Because depreciation is a noncash deductible expense, it shields $90,000 of the cash savings from taxation. Accordingly, $60,000 ($150,000 -- $90,000) of the additional net cash inflow must come from after-tax net income. At a 40% tax rate, $60,000 of after-tax income equals $100,000 ($60,000 ÷ 60%) of pre4ax income from cost savings, and the out flow for taxes is $40,000. Thus, the annual reduction in cash operating costs required is $190,000 ($150,000 additional net cash inflow required + $40,000 tax outflow).
The length of time required to recover the initial cash outlay of a capital project is determined by using the
Answer(s): B
The payback method measures the number of years required to complete the return of the original investment. This measure is computed by dividing the net investment by the average expected cash inflows to be generated, resulting in the number of years required to recover the original investment. The payback method gives no consideration to the time value of money, and there is no consideration of returns after the payback period.
Which one of the following statements about the payback method of investment analysis is correct? The payback method
Answer(s): A
The payback method calculates the amount of time required to complete the return of the original investment, i.e.1 the time it takes for a new asset to pay for itself. Although the payback method is easy to calculate, it has inherent problems. The time value of money and returns after the payback period are not considered.
The payback reciprocal can be used to approximate a project's
The payback reciprocal (1 + payback) has been shown to approximate the internal rate of return' (IRR) when the periodic cash flows are equal and the life of the project is at least twice the payback period:
The bailout payback method
The payback period equals the net investment divided by the average expected cash flow, resulting in the number of years required to recover the original investment. The bailout payback incorporates the salvage value of the asset into the calculation. It determines the length of the payback period when the periodic cash inflows are combined with the salvage value. Hence, the method measures risk. The longer the payback period, the more risks' the investment.
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