The payback period is the number of years it takes for the initial investment in a project to be returned, without considering the time value of money. The new equipment will cost $450,000, and the company needs that amount returned within three years. The depreciation tax shield will be $36,000 per year ($450,000 ÷ 5 × .40). Therefore, in three years, $108,000 of the investment will have been returned by means of the depreciation tax shield, leaving $342,000 to be returned in increased cash flow after taxes. Jasper's tax rate is 40%. Therefore, the before-tax increased cash flow over the three year payback period needs to be $342,000 ÷ (1 ? .40), or $570,000. The annual increase in cash flow needed, then, is $570,000 ÷ 3, or $190,000.
$100,000 in annual before-tax cash flow would equal $60,000 in annual after-tax cash flow. When $60,000 is added to the depreciation tax shield of $36,000 per year, the resulting $96,000 of annual net cash flow increase would not achieve a payback period of 3 years.
$114,000 is the amount of increased cash flow from operations net of tax that is required. However, it is not the amount that the sorter must generate in annual reductions of cash operating costs in order to achieve a three-year payback.
$150,000 is the net after-tax cash flow increase required each year to achieve a payback period of 3 years on a $450,000 investment. However, that is not what the question asks.
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