(Ignore income taxes in this problem.) Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions.The auto was purchased for $24,000 and will have a 6-year useful life and a $6,000 salvage value.Delivering prescriptions (which the pharmacy has never done before) should increase gross revenues by at least $28,000 per year.The cost of these prescriptions to the pharmacy will be about $22,000 per year.The pharmacy depreciates all assets using the straight-line method.The payback period for the auto is closest to:

A) 2 years
B) 1.8 years
C) 4 years
D) 1.2 years

Question

Sacoya Brooks · Accepted Answer

Final Answer : C, Explanation :  The formula for payback period is:Payback Period = Cost of Investment / Annual Cash InflowsFirst, we need to calculate the annual depreciation expense for the auto:Depreciation Expense = (Cost of Asset - Salvage Value) / Useful LifeDepreciation Expense = ($24,000 - $6,000) / 6Depreciation Expense = $3,000 per yearNext, we need to calculate the annual cash inflows from delivering prescriptions:Annual Revenues = $28,000Annual Costs = $22,000Annual Cash Inflows = Annual Revenues - Annual CostsAnnual Cash Inflows = $28,000 - $22,000Annual Cash Inflows = $6,000 per yearNow we can calculate the payback period:Payback Period = Cost of Investment / Annual Cash InflowsPayback Period = $24,000 / $6,000Payback Period = 4 yearsTherefore, the best choice is C because the payback period is 4 years. Annual net cash inflow = $28,000 - $22,000 = $6,000Payback period = Investment required ÷ Annual net cash inflow= $24,000 ÷ $6,000 per year = 4 years

Definitions

Learning Objectives

Learning Objectives

Related questions