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A company is planning to purchase a machine that will cost $26,532, have a six-year life, and will have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the payback period for this machine? Sales   $ 99,000Costs:    Manufacturing $ 59,400  Depreciation on machine 4,400  Selling and administrative expenses 33,000 (96,800)Income   $ 2,200

Question

A company is planning to purchase a machine that will cost 26,532,haveasix−yearlife,andwillhavenosalvagevalue.Thecompanyexpectstosellthemachine′soutputof3,000unitsevenlythroughouteachyear.Aprojectedincomestatementforeachyearoftheasset′slifeappearsbelow.Whatisthepaybackperiodforthismachine? Sales 26,532, have a six-year life, and will have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the payback period for this machine? Sales   99,000Costs:    Manufacturing 59,400 Depreciationonmachine4,400 Sellingandadministrativeexpenses33,000(96,800)Income  59,400  Depreciation on machine 4,400  Selling and administrative expenses 33,000 (96,800)Income   2,200

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Solution

The payback period is a financial metric that is widely used to measure the length of time it takes to recover the cost of an investment. In other words, the payback period is the break-even point in time.

Here's how to calculate the payback period for the machine:

  1. First, determine the net annual cash inflow from the machine. This is calculated by adding back the depreciation to the net income since depreciation is a non-cash expense.

    Net income = 2,200Depreciation=2,200 Depreciation = 4,400 Net annual cash inflow = Net income + Depreciation Net annual cash inflow = 2,200+2,200 + 4,400 = $6,600

  2. Next, calculate the payback period. This is done by dividing the cost of the machine by the net annual cash inflow.

    Cost of machine = 26,532Paybackperiod=Costofmachine/NetannualcashinflowPaybackperiod=26,532 Payback period = Cost of machine / Net annual cash inflow Payback period = 26,532 / $6,600 = 4.02 years

So, the payback period for the machine is approximately 4.02 years. This means that it will take about 4 years for the company to recover the cost of the machine from its net cash inflows.

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