Fire Corp. is considering the purchase of a new piece of equipment. The equipment costs $50,000 and will have a salvage value of $5,000 after nine years. Using the new piece of equipment will increase Fire's annual cash flows by $6,000.a. What is the payback period for the new piece of equipment?b. Suppose that the increase in cash flows was $10,000 in the first year, then decreased by $1,000 each year over the life of the equipment. What is the payback period for the equipment?
What will be an ideal response?
a. 8.33 years = $50,000/$6,000
b. 7.33 years: $50,000 ? $10,000 ? $9,000 ? $8,000 ? $7,000 ? $6,000 ? $5,000 ? $4,000 = $1,000 left to be paid off in year 8, when $3,000 is earned. 7 + $1,000/$3,000 = 7.33 years
Payback period is calculated by dividing the initial investment by the annual net cash flow when cash flows are equal. When cash flows are not equal, the net cash flows should be subtracted from the initial investment until it is paid back.
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