Olsen Inc Purchased a $600,000 Machine to Manufacture a Specialty Tap

question 3

Multiple Choice

Olsen Inc. purchased a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen can sell all that it could manufacture for the next 10 years. To encourage capital investments, the government exempts taxes on profits from new investments in this type of machinery. This legislation most likely will remain in effect in the foreseeable future. The equipment is expected to have 10 years of useful life and no salvage value at the end of this 10-year period. The firm uses straight-line depreciation. The net cash inflow is expected to be $144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments.

Assume that after-tax cash inflows occur evenly throughout the year. The estimated payback period for this proposed investment, in years, is (rounded to two decimal places) :

• A) 4.17 years.
• B) 5.05 years.
• C) 5.43 years.
• D) 5.67 years.
• E) 7.14 years.

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Definitions:

Real Rate of Interest

The interest rate adjusted for inflation, reflecting the true cost of borrowing and the real yield to lenders or investors.

Inflation Rate

The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling over time.

Real Rate of Return

The yearly rate of return on an investment, corrected for price changes stemming from inflation or external factors.

Annual Interest Rate

The percentage of the principal that is paid as interest to the lender over the course of one year, not accounting for compounding.