The Higgins Company has just purchased a piece of equipment at a cost of $120,000. This equipment will reduce operating costs by $40,000 each year for the next eight years. This equipment replaces old equipment which was sold for $8,000 cash. The new equipment has a payback period of:A. 8.0 yearsB. 2.8 yearsC. 10.0 yearsD. 3.0 years

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Business

Keagan Beck

18 October, 14:30

The Higgins Company has just purchased a piece of equipment at a cost of $120,000. This equipment will reduce operating costs by $40,000 each year for the next eight years. This equipment replaces old equipment which was sold for $8,000 cash. The new equipment has a payback period of:A. 8.0 yearsB. 2.8 yearsC. 10.0 yearsD. 3.0 years

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Darion Maxwell · Answer 1

B. 2.8 years

Explanation:

Initial investment = - 120,000 + 8,000 = - 112,000

Yr 1 cash inflow = 40,000, hence net CF = 40,000-112,000 = - 72,000

Yr 2 cash inflow = 40,000, hence net CF = 40,000 - 72,000 = - 32,000

Yr 3 cash inflow = 40,000, hence net CF = 40,000-32,000 = 12,000

Payback period = last year with negative net CF + (absolute net CF that year / total CF the following year)

= 2 + (32,000/40,000)

= 2 + 0.8

= 2.8 years