Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years.
1. What is the payback period for this project?
2. If their acceptance period is three years, will this project be accepted?
The capital budgeting is an exercise initiated by top management necessitate by the growth opportunities and stated objectives and targets of the company. The different capital projects are evaluated and selected based on the best fit. The various methods used in evaluation projects are Payback Period, NPV, and IRR
Answer and Explanation:
The following information is provided for the new machinery
- The purchase cost is $1,250,000
- The expected life of the investment is 5 years
- The annual cash inflows for this investment is $375,000
- The payback period formula is used to calculate the period
- Payback Period = Project cost / net cash inflow per year
=$1,250,000 / $375,000
= 3.33 years
1) The payback period for this project is 3.33 years or 3 years and 4 months
2) If their acceptance period is three years, the project should be rejected as the payback period for this project is 3.33 years
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 24