Q20E - Horngren'S Financial And Managerial Accounting

Question

Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.

Step-by-Step Solution

Answer

The payback period is 5.9 years.

Step 1: Meaning of Capital Investment

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

Step 2: Computing payback period

Calculating annual cash flow

$\begin{array}{rcl}Annual cash flows from the two years& =& First year+Second year\\ & =& \$310,000+\$270,000\\ & =& \$580,000\end{array}$

Calculating payback period

$\begin{array}{rcl}Payback period& =& \frac{Initial Investment}{Annual cash flows}\\ & =& \frac{\left(\$1,512,000-\$580,000\right)}{\$240,000}\\ & =& \frac{\$932,000}{\$240,000}\\ & =& 3.9years\end{array}$

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