Question

Problem 1: Due to increased demand, the management of Bubble Tea Beverage Company is considering to purchase new equipment to increase the production and sales revenues. The useful life of the equipment is 5 years and the company's maximum desired payback period is 2 years. The inflow and outflow of cash associated with the new equipment is given below: $110,000 $100,000 The initial cost of equipment Annual cash inflow: Sales (all cash) Annual cash outflow: Cost of ingredients Salaries expenses Maintenance expenses $20,000 $30,000 $1,000 Required: Draw a timeline of cash flows for this scenario. Compute payback period for this equipment purchase. Should Bubble Tea Beverage Company purchase the new equipment? Why or why not?

Answer 1

(Amounts in $) Statement showing Timeline of Cash Flows for Bubble Tea Beverage Co. Years Particulars L 1 2 3 4 Cash Inflows Sales - All Cash 1,00,000 1,00,000 1,00,000 1,00,000 5 1,00,000 (1,10,000) Cash Outflows Initial cost of Equipment Cost of ingredients Salaries expenses Maintenance expenses (20,000) (30,000) (1,000) (20,000) (30,000) (1,000) (20,000) (20,000) (30,000) (30,000) (1,000) (1,000) (20,000) (30,000) (1,000) 49,000 49,000 49,000 49,000 Net Cash inflows/(Outflows) (1,10,000) 49,000 * Amounts in brackets represents negative values Initial Cost of Asset Payback Period =- Net Annual cash Inflows Using the above formula, we will compute the payback period of Bubble Tea co Payback period = $ 110000 $49000 = 2.24 years Actual Payback period exceeded the maximum desired payback period of 2 years. Thus, Bubble Tea Beverage co should not purchase the equipment.

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