Question

(Ignore income taxes in this problem.) Jarvey Company is studying a project that would have a ten-year life
and would require a $450,000 investment in equipment which has no salvage value. The project would provide net operating income each year as follows for the life of the project:

Sales ............................................... . $500,000

Less cash variable expenses ............ . 200,000

Contribution margin ........................ . 300,000

Less fIxed expenses:

fixedcash expenses ..................... .$150,000

Depreciation expenses .................. .45,000 . 195.000

Net operating income ...................... $105,000

The company's required rate of return is 12%.

What is the payback period for this project?

Answer 1

Answer:

payback period is 3 years.

Explanation:

Given that,

Net operating income (EBIT) = $105,000

Depreciation = $45,000

Required rate of return = 12%

First, we have to calculate the operating cash flows for the first 10 yrs, and then we have to calculate the Payback period.

In this problem, income taxes are ignored.

Hence the effect of tax on cash flows is zero.

Operating cash flows:

= EBIT + Depreciation - Taxes  

= $105,000 + $45,000 - $0

= $150,000

Therefore, the operating cash flows for 10 years is $150,000

The cash flows are even (same) for 10 years.

Payback period:

= Cost of the investment ÷ Net annual cash flows

= $450,000 ÷ $150,000

= 3 years

Therefore, the time to recover the initial investment is 3 years.

Hence, the payback period is 3 years.