A machine can be purchased for $250,000 and used for five years, yielding the following net incomes. In projecting net incomes, straight-line depreciation is applied, using a five-year life and a zero salvage value.

Year 1 Year 2 Year 3 Year 4 Year 5

Net income $ 17,000 $ 42,000 $ 119,000 $ 63,500 $ 168,000

Compute the machineâs payback period (ignore taxes).

2.53 years

Explanation:

For computing the payback period, first we have to find out the depreciation expense which is shown below:

= (Purchase value of machine - residual value) : (useful life)

= ($250,000 - $0) : (5 years)

= ($250,000) : (5 years)

= $50,000

Now the cash flows would be

Year Net income Depreciation Net cash flow

Year 0 ($250,000)

Year 1 $17,000 $50,000 $67,000

Year 2 $42,000 $50,000 $92,000

Year 3 $119,000 $50,000 $169,000

Year 4 $63,500 $50,000 $113,500

Year 5 $168,000 $50,000 $218,000

As we add the first 2 year net cash flows than it would be $159,000

Now we deduct the $159,000 from the $2500,000, so the amount would be $91,000 as if we added the third year cash inflow so the total amount exceed to the initial investment. Therefore, we subtract that, and the next year's cash inflow will be $169,000.

So, the payback period would be

= 2 years + $91,000 : $169,000

= 2.53 years