Question

Problem 2: The management of Tech21 Inc. wants to reduce its labor cost by installing a new machine that would free up the time of two employees, allowing them to do other production work that is chargeable to customers. Two types of machines could be purchased that would do the job - machine A and machine B. Cost of machine Annual labor cost saving Expected life of machine Machine A $60,000 $10,000 10 years Machine B $40,000 $10,000 4 years Required: Draw a cash flow time line for each machine option. Which is the best machine to purchase according to payback method? The company requires a 3 year or shorter payback period. Which machine would you recommend? What other factors might influence the recommendation decision? List three or more.

Answer 1

Answer:

Particulars	Machine A	Machine B
Cost of the machine	60000	40000
Net annual benefit	10000	10000
Life (in years)	10	4

Year	Machine A savings	Machine A cumulative savings	Machine B savings
1	10000	10000	10000
2	10000	20000	10000
3	10000	30000	10000
4	10000	40000	10000
5	10000	50000
6	10000	60000
7	10000	70000
8	10000	80000
9	10000	90000
10	10000	100000
Payback period:
Formula:	=Year + (Cumulative return greater than initial outflow-initial outflow)/(Cumulative return greater than initial outflow-Cumulative return for the previous year)	6 years, since the Machine A is able to cover the investment in 6 years.	4 years, since the Machine A is able to cover the investment in 6 years.
Conclusion/Rank		II	I
			Since, Machine B is able to recover its expenses in just 4 years.

Answer a. According to the Payback period method, the best option is Machine B since it is able to recover its expenses in just 4 years but Machine A in 6 years.

Answer b. If the company requires a 3 year or shorter period, both the machines are not feasible since in Machine B also atleast 4 years is required to recover the cost.

Answer C:

The other factors that might influence investment decision are as follows:

i. Rate of return on investment;

ii. Long-term useful life of the machine and the ability to generate revenue;

iii. Salvage value of each machines;

iv. Replacement cost;