Detailed Answer
Answer (B) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price – $450 variable costs), a total of $200,000 per year for 4,000 units. This amount will be subject to taxation. However, for the first 5 years, a depreciation deduction of $42,000 per year ($210,000 ÷ 5 years) will be available. Thus, annual taxable income will be $158,000 ($200,000 – $42,000). At a 40% tax rate, income tax expense will be $63,200, and the net cash inflow will be $136,800 ($200,000 – $63,200). When annual cash inflows are uniform, the payback period is calculated by dividing the initial investment ($210,000) by the annual net cash inflows ($136,800). Dividing $210,000 by $136,800 produces a payback period of 1.54 years.