Question

Henry Hardware is adding a new product line that will require an investment of $1,512,000.Managersestimatethatthisinvestmentwillhavea10-yearlifeandgeneratenetcashinflowsof$310,000 the first year, $270,000thesecondyear,and$240,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.

Short answer

The payback period is 5.9 years.

Step-by-step solution

Meaning of Capital Investment

Capital investment is a sum of cash to assist a company in accomplishing its objectivesor buying long-term resources.

Computing payback period

Calculating annual cash flow

$\begin{array}{rcl}Annualcashflowsfromthetwoyears& =& Firstyear+Secondyear\\ & =& \$310,000+\$270,000\\ & =& \$580,000\end{array}$

Calculating payback period

$\begin{array}{rcl}Paybackperiod& =& \frac{InitialInvestment}{Annualcashflows}\\ & =& \frac{\left(\$1,512,000-\$580,000\right)}{\$240,000}\\ & =& \frac{\$932,000}{\$240,000}\\ & =& 3.9years\end{array}$

The payback period is 5.9 years (2 years + 3.9 years)