Exercise 16-12 Determining the payback period LO 16-4 Fanning Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $23,100,000; it will enable the company to increase its annual cash inflow by $6,600,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $32,000,000; it will enable the company to increase annual cash flow by $8,000,000 per year. This plane has an eight-year useful life and a zero salvage value. Required Determine the payback period for each investment alternative and identify the alternative Fanning should accept if the decision is based on the payback approach. (Round your answers to 1 decimal place.)

First plane = 3.5 years

Second plane = 4 years

The first plane should be chosen.

Explanation:

Payback period calculates the amount of time it takes to recover the amount invested in a project from its cumulative cash flows.

Payback period = Cost/ annual cash flows

For the first plane: $23,100,000 / 6,600,000 = 3.5 years

For the second plane = $32,000,000 / $8.000,000 = 4 years

Using the cash payback period, the plane with the shorter payback period would be chosen. So the first plane would be chosen.

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