Compute the payback period for each of these two separate investments: A new operating system for an existing machine is expected to cost $290,000 and have a useful life of six years. The system yields an incremental after-tax income of $83,653 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $11,000. A machine costs $210,000, has a $15,000 salvage value, is expected to last eleven years, and will generate an after-tax income of $46,000 per year after straight-line depreciation.

Project A's payback period = 2.23 years

Project B's payback period = 3.3 years

Explanation:

                                                              project A                project B

initial investment                                 $290,000               $210,000

useful life                                               6 years                   11 years

yearly cash flow                     $83,653 + $46,500     $46,000 + $17,727

                                                         = $130,153                = $63,727

salvage value                                          $11,000                 $15,000

payback period                      $290,000 / $130,153  $210,000 / $63,727

                                                        = 2.23 years              = 3.3 years

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