Use the payback method to determine whether Preston should purchase this plant.

QUESTION

Using the payback and rate of return methods to make capital investment decisions
Preston, Co., is considering acquiring a manufacturing plant. The purchase price is $1,100,000. The owners believe the plant will generate net cash inflows of $297,000 annually. It will have to be replaced in six years.
Requirement
1. Use the payback method to determine whether Preston should purchase this plant.
Payback Period = Initial Investment / Annual Net Cash Inflow = $1,100,000 / $297,000 = 3.70 years Since the owner is able to redeem its initial investment in 3.70 years only, he will

earn a profit after this period for next 2.3 years before replacing the plant. Hence, Peterson should purchase this plant.

ANSWER:

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