Question

5.2 Camptown Togs, Inc., a children's clothing manufacturer, has always found payroll processing to be costly because it must be done by a clerk. The number of piece-goods coupons received by each employee is collected and the types of tasks performed by each employee are calculated. Not long ago, an industrial engineer designed a system that partially automates the process by means of a scanner that reads the piece-goods coupons. Management is enthusiastic about this system because it utilizes some personal computer systems that were purchased recently. It is expected that this new automated system will save $45,000 per year in labor. The new system will cost about $30,000 to build and test prior to operation. It is expected that operating costs, including income taxes, will be about $5,000 per year. The system will have a five-year useful life. The expected net salvage value of the system is estimated to be $3,000. a. Identify the cash inflows over the life of the project. b. Identify the cash outflows over the life of the project. c. Determine the net cash flows over the life of the project. d. How long does it take to recover the investment? e. If the firm's interest rate is 15% after taxes, what would be the discounted payback period for this project?

Please provide calculation equations.

Answer 1

Answer a:

Year 0 1 2 4 5 Cash Inflows: $45,000$45,000$45,000 $45,000$45,000 Savings in labor cost $3,000 Salvage value 0 $45,000 $45,000 $45,000 $45,000 $48,000 Cash inflows

Answer b:

Year 0 2 4 5 Cash Outflows: Operating Costs $5,000 $5,000 $5,000 $5,000 $5,000 $30,000 Initial Investment $30,000 $5,000 $5,000 $5,000 $5,000 $5,000 Cash outflows

Answer c:

Year 0 1 Cash Inflows: $45,000$45,000$45,000 $45,000 $3,000 $45,000 Savings in labor cost Salvage value $45,000$45,000$45,000 $48,000 Cash inflows O $45,000 Cash Outflows: $5,000 $5,000 $5,000 $5,000 $5,000 Operating Costs $30,000 Initial Investment $30,000 $5,000 $5,000 $5,000 $5,000 $5,000 Cash outflows Net Cash flow (Cash Inflows - Cash outflow) ($30,000)$40,000$40,000$40,000 $40,000 $43,000

Answer d:

Time taken to recover the investment = Payback period = 0.75 Years

Year 1 2 Cash Inflows: $45,000$45,000$45,000 $45,000$45,000 Savings in labor cost $3,000 Salvage value O$45,000 $45,000 $45,000 $45,000 $48,000 Cash inflows Cash Outflows: $5,000 $5,000 $5,000 $5,000 $5,000 Operating Costs $30,000 Initial Investment $30,000 $5,000 $5,000 $5,000 $5,000 $5,000 Cash outflows Net Cash flow (Cash Inflows - Cash outflow) ($30,000)$40,000$40,000 $40,000$40,000 $43,000 ($30,000) $10,000 $50,000$90,000 $130,000 $173,000 0.75 Years Cumulative cash flows Payback period

In year 1 itself the cumulative cash flow is positive.

Payback period = Initial Investment / Year 1 net cash flow = 30000 /40000 = 0.75 Years

Answer e:

Discounted payback period = 0.86 Years

Working:

Year 0 1 5 Cash Inflows: $45,000 $45,000 $45,000 $45,000 $45,000 $3,000 Savings in labor cost Salvage value $45,000 $45,000 $45,000 $45,000 $48,000 Cash inflows 0 Cash Outflows: Operating Costs $5,000 $5,000 $5,000 $5,000 $5,000 $30,000 Initial Investment $30,000 $5,000 $5,000 $5,000 $5,000 $5,000 Cash outflows ($30,000)$40,000 $40,000 $40,000 $40,000 $43,000 Net Cash flow (Cash Inflows - Cash outflow) PV factor (1/(1+15%) ^Year) Discounted net cash flows (PV factor* net cash flows) 0.57175 1 0.86957 0.75614 0.65752 0.49718 (30,000.00) 34,782.61 (30,000.00) 0.86 Years 30,245.75 26,300.6522,870.13 35,028.36 61,329.00 84,199.13 105,577.73 21,378.60 Cumulative discounted net cash flows 4,782.61 Discounted payback period

In year 1 itself the cumulative discounted net cash flow is positive.

Payback period = Initial Investment / Year 1 discounted net cash flow = 30000 /34782.61 = 0.86 Years