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Payback period

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Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period?

a. 2 years
b. 4 years
c. 6 years
d. 8 years
e. 10 years

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The solution explains how to calculate the payback period.

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The payback period is the time taken to recover the initial investment. In order to find the payback period, we cumulate the cash flows till we get zero, since at that ...

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