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Jasper Company has a payback goal of three years on acquisitions of new equipment. A new piece of equipment that costs $450,000 and that has a five-year life is being considered. Straight-line (SL) depreciation will be used, with zero salvage value. Jasper is subject to a 40% combined income tax rate, t. To meet the company's payback goal, the equipment must generate reductions in annual cash operating costs of at least:

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Answer: $190,000

Explanation:

The required annual return should pay back the $450,000 in 3 years so that amount will be:

= 450,000 / 3

= $150,000

Depreciation will be:

= 450,000 / 5 years useful life

= $90,000

Assume the reductions that should be generated is r:

Required return = r - (r - depreciation) * tax rate

150,000 = r - (r - 90,000) * 40%

150,000 = r - 0.4r + 36,000

0.6r = 150,000 -36,000

r = 114,000 / 0.6

= $190,000

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