Question

Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 7 percent discount rate for their production systems. Year 0 1 2 3 System 1 -$13,600 13,600 13,600 13,600 System 2 -$46,200 32,400 32,400 32,400 What are the payback periods for production systems 1 and 2? (Round answers to 2 decimal places, e.g. 15.25.) years and Payback period of Payback period of System 1 is System 2 is years If the systems are mutually exclusive and the firm always chooses projects with the lowest payback period, in which system should the firm invest? The firm should invest in

Answer 1

To find the payback period, we need to find the cumulative cash flows. Payback period is the year in which the initial investment is fully recovered

System 1

Year	Cash Flow	Cumulative Cash Flow
0	-13600	-13600
1	13600	0
2	13600	13600
3	13600	27200

Hence, Payback Period = 1 year

System 2

Year	Cash Flow	Cumulative Cash Flow
0	-46200	-46200
1	32400	-13800
2	32400	18600
3	32400	51000

Payback Period = 1 + 13800/32400 = 1.43 years

System 1 should be chosen since it has a lower Payback period