Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 40% income tax bracket. Predicted annual after-tax cash inflows from this investment are $28,000, $11,000, $3,000, $5,000 and $2,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.
The payback period in years (rounded to the nearest 10th of a year) for this proposed investment is (assume that the after-tax cash inflows occur evenly throughout the year):
3.5 years
1. Cum. After-tax cash flow, Period 0 = ($45,000).
2. Cum. After-tax cash flow, Period 1 = ($45,000) + $28,000 = ($17,000)
3. Cum. After-tax cash flow, Period 2 = ($17,000) + $11,000 = ($6,000)
4. Cum. After-tax cash flow, Period 3 = ($6,000) + $3,000 = ($3,000)
5. Cum. After-tax cash flow, Period 4 = ($3,000) + $5,000 = $2,000
6. Cum. After-tax cash flow, Period 5 = $2,000 + $2,000 = $4,000
7. Therefore, Payback = 3 + ($2,000/$4,000) = 3.5 years
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