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A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $12,000 per year including depreciation of $3,000 per year. Income tax expense is $1,600 per year based on a tax rate of 40%. What is the payback period for the new machine?

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Answer:

$8.9 Years

Explanation:

The computation of payback period for the new machine is shown below:-

Annual Cash flow

Sales                             $16,000

Expenses                      $9,000

($12,000 - $3,000)

Depreciation                 $3,000

Net revenue                  $4,000

Tax                                  $1,600

($4,000 × 40%)

Net income after tax      $2,400

Add: Depreciation           $3,000

Cash Flow                       $5,400

Now, we compute the payback period

Payback period = Initial investment ÷ Annual cash flow

= $48,000 ÷ $5,400

= $8.9 Years

So, for computing the payback period we simply applied the above formula.

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