Quip Corporation wants to purchase a new machine for $284,000. Management predicts that the machine will produce sales of $187,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $78,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $50,000. Quip's combined income tax rate, t, is 20%.

What is the payback period for the new machine (rounded to the nearest one-tenth of a year)? Assume that the after-tax cash inflows occur evenly throughout the year.

2.9 years


1. SL depreciation expense per year = ($284,000 ? $50,000)/5 years = $46,800

2. Pre-tax income per year = Sales ? depreciation ? cash expenses = $187,000 ? $46,800 ? $78,000 = $62,200

3. Tax expense per year = $62,200 × 0.20 = $12,440

4. After-tax income = Pre-tax income ? income taxes = $62,200 ? $12,440 = $49,760

5. Annual after-tax cash flow = after-tax income + depreciation expense = $49,760 + $46,800 = $96,560

6. Payback (in years) = original investment cost/annual after-tax cash inflow = $284,000/$96,560 = 2.941 years = 2.9 years, rounded to one decimal place.