Question

The management of BNZ bank is considering an investment in automatic teller machines. The machines would cost $513,000 each and have a useful life of 7 years. The bank’s finance manager has estimated that the automatic teller machines will save the bank $110,000 per machine during each year of their life. The machines will have no residual value. Ignore company income taxes.

You are required to:

a) Calculate the payback period for the proposed investment.

b) Calculate the net present value of the proposed investment, assuming a discount rate of:

(i) 8%,

(ii) 10%,

(iii) 12%.

c) What can you conclude from your answers to questions a) and b) about the limitations of the payback method?

Answer 1

Solution: a) Initial investment /Annual cash inflow Payback period 513000| 110000 4.66 Years b) NPV Year Parti Part ii Part iii Cash flow PV factor at 8% PV at 8% PV factor at 10% PV at 10% PV factor at 12% PV at 12% b c=a* b d e=a*d If g=a*f 0 -513000 1.00000 -513000.00 1.00000-513000.00 1.00000-513000.00 1 110000 0.92593 101851.85 0.90909 100000.00 0.892861 98214.29 2 1100001 0.85734 94307.27 0.82645 90909.09 0.79719 87691.33 3 110000 0.79383 87321.55 0.75131 82644.63 0.71178 78295.83 4 1100001 0.73503 80853.28 0.68301 75131.48 0.63552 69906.99 5 110000 0.68058 74864.15 0.62092 68301.35 0.5674362416.95 110000 0.63017 69318.66 0.56447 62092.13 0.50663 55729.42 7 110000 0.58349 64183.94 0.51316 56447.39 0.45235 49758.41 NPV 59700.71 NPV 22526.07 NPV -10986.78 1. Payback period ignores time value of money and the cash flow after payback period.