A company is considering investing in a new machine to replace an old machine. The estimated...
A company is considering investing in a new machine to replace an old machine. The estimated operating costs of the two machines per year are:
OLD MACHINE NEW MACHINE
DEPRECIATION $64,000 $96,000
LABOR $230,400 $173,600
REPAIRS $62,400 $13,600
OTHER COST $38,400 $9,600
The cost of the new machine is $480,000, and it has no salvage value at the end of its useful life.
a. What is the estimated life of the new machine?
b. Compute the payback period for the new machine; ignore income taxes.
c. Assume the same data as given above except that the repair costs on the new machine are
expected to increase by $9,600 per year. Compute the payback period for the new machine.
Homework Answers
Requirement 1:
Estimated useful life of the new machine = Cost of new machine ÷ Depreciation expense
=$480,000/$96,000
=5 Years
Requirement 2:
| Incremental cash inflows | |||
| Old Machine (i) | New Machine (ii) | Savings (i) - (ii) | |
| Labor | $230,400 | $173,600 | $56,800 |
| Repairs | $62,400 | $13,600 | $48,800 |
| Other costs | $38,400 | $9,600 | $28,800 |
| Total increment cash inflows | $134,400 | ||
Payback period = Cost of new machine ÷ Average annual cash inflows
= $480,000/$134,400
= 3.57 years
Requirement 3:
| Year | Cash inflows | Accumulated cash inflows |
| 1 | $134,400 | $134,400 |
| 2 | $124,800 | $259,200 |
| 3 | $115,200 | $374,400 |
| 4 | $105,600 | $480,000 |
| 5 | $96,000 |
Note: Cash inflows are decreased by $9,600 every year because operating costs are increased by $9,600 every year.
Pay back period is 4 years as the accumulated cash inflows are equal to the cost of new machine.
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