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20 December, 19:32

Payson Manufacturing is considering an investment in a new automated manufacturing system. The new system requires an investment of $1,200,000 and either has: Even cash flows of $300,000 per year or The following expected annual cash flows: $150,000, $150,000, $400,000, $400,000, and $100,000.

Calculate the payback period for each case.

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  1. 20 December, 20:42
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    The payback period for even cash flow is 4 years

    The payback period for uneven cash flows is 5 years

    Explanation:

    The payback period is a term used in capital budgeting and is one of the ways of assessing a project. It calculates the time required to recover the total cost invested in the project initially.

    Payback period for Even cash flows

    Payback period = Number of years till last period + Unrecovered cost at the beginning of the last period for payback / Total cash flows during the last period

    The last period here refers to the period in which the cost will be recovered.

    The initial cost is $1200000

    Recovery till last year of payback = 300000 + 300000 + 300000 = $900000

    Payback period = 3 + 300000 / 300000 = 4 years

    Payback under uneven cash flows

    Initial cost = $1200000

    Recovery till last year of payback = 150000 + 150000 + 400000 + 400000 = 1100000

    Payback period = 4 + 100000 / 100000 = 5 years
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