Question

The plant manager at a company would like to perform an analysis for a new $130,000 machine. If she estimates benefits of $25,000 in the first year, and benefits are increasing by 11% per year a. What is the payback period for the machine? (Hint: The Payback Period is the length of time required to recover the initial cash outflows through the successive cash inflows, thus find the time when Cumulative PW (at 0%) becomes positive) b. Suppose that the machine life is 5 years with no salvage value at the end of its useful life. If the MARR of the company is 8% per year, is this investment acceptable? Why?

Answer 1

a)

To find the payback period, we have to develop the cash flow table that contains the initial investment, estimated benefits along with the cumulative cash flows.

Year Cash flows Cumulative cash flows 0 ($130,000)| ($130,000) 1 $25,000 ($105,000) 2 $27,750.00 ($77,250) 3 $30,802.50 ($46,448) 4 $34,190.78 ($12,257) 5 $37,951.77 $25,695

$12257 Payback period = 4years + $37951.77

Payback period = 4.32 years

---------------------------------------------------------------------------------------

b)

To decide if the investment is acceptable, we have to find the net present value of the investment at a MARR of 8%.

$25,000 $27750 $30802.50 $34190.78 $37951.77 Net present value = -$130,000+ + + + (1 +0.08)1'(1 + 0.08) '(1 + 0.08) 3 '(1 + 0.08) '(1 + 0.08) +

Net present value = $ - 7648.10

The investment is not acceptable because the net present value is negative.