The Easton manufacturing Company is looking to replace its conveyor belt system. A new system will cost $345,000, and will result in cost savings of $220,000 in the first year, followed by savings of $100,000 per year over the following 3 years. The payback period for this project is closest to:

2.25 years

Explanation:

The computation of payback period is shown below:-

Year Cash flows Cumulative Cash flows

0 ($345,000) ($345,000)

1 $220,000 ($125,000)

2 $100,000 ($25,000)

3 $100,000 $75,000

4 $100,000 $175,000

Payback period = Last period with a negative cumulative cash flow + (Absolute value of cumulative cash flows at that period : Cash flow after that period)

=2 + ($25,000 : $100,000)

= 2.25 years

So, for computing the payback period we simply applied the above formula.