As you know, to find out Payback, denominator would be "
after tax cash flow".
But in the question, he gave after tax revenue, But we need "after tax cash flow" and do following calculation,
Before tax revenue = 180,000/0.8 = $225,000
Denominator Calculation:
Revenue 225,000
Minus - Depreciation (
100,000)Cash Flow 125,000
Tax (20%)
(25,000)Net of Tax 100,000 (125,000*0.8)
Add back depreciation
100,000After Tax CF 200,000
And you the answer would be 2.5Y------------------------------
Zubair
------------------------------
Original Message:
Sent: 02-17-2020 05:53 AM
From: Shilpa Sinha
Subject: Payback period
Dear All,
Why is pre-tax cashflow considered for the calculation below instead of the after-tax given in the problem?
Study Unit 9: Investment Decisions | Subunit 4: Payback and Discounted Payback
| | | | Question: 44 | A company is planning to purchase a new machine that will cost $450,000 with delivery and setup costs of $50,000. The machine will be depreciated using the straight-line method over 5 years with a zero salvage value at the end. It is expected that the machine will help the company generate additional after-tax net revenues of $180,000 annually. The company is subject to a 20% income tax rate. The machine payback period is | | | | | | | | | Answer (C) is correct. The traditional payback period is the number of years required to return the original investment. There is no discount for the time value of money. If the cash flows are constant, the formula is Payback = Initial investment ÷ Annual cash flows. The initial investment is $500,000 ($450,000 + $50,000). Dividing the $500,000 by the annual cash flows of $200,000 results in a payback of 2.5 years. The annual cash flows of $200,000 are calculated by subtracting the income tax expense from the cash flows from operations. The cash flows from operations also have to be calculated since the question gives only the after-tax net revenues. Taxes are calculated as follows: Tax = (Before-tax profit – Depreciation) × .2, while Before-tax profit – Tax = $180,000. Combining the two equations yields BTP – [(BTP – 100,000) × .2] = $180,000, or .8BTP + 20,000 = $180,000, or .8BTP = $160,000. Therefore, BTP = $200,000. | | |
|
|