George Company has the opportunity to purchase an asset that costs $40,000. The asset is expected to increase net income by $10,000 per year. Depreciation expense will be $5,000 per year. Based on this information the payback period is:

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Zviko Zviko · Answer 1 · 2021-06-24T02:36:47+02:00

Answer:

2 years 8 months.

Explanation:

The payback period is the length of time that it takes for the future cash flows to equal the amount of initial investment.

We use cashflows instead of net income in payback calculation. Therefore, add back the depreciation expense.

Yearly Cash flow will thus be $15,000 ($10,000 + $5,000)

Payback Period :

$40,000 = $15,000 (Year 1) + $15,000 (Year 2 )+ $10,000/$15,000 x 12 (Year 3)

This gives a payback period of 2 years 8 months