Question

2. A Company is considering replacing one of existing machine with either a state of the art “Automatic Machine” which will reduce the labor cost by 80% or with a standard machine. The automatic machine will cost ₹ 3,50,000 with an estimated life of 7 years, whereas the standard machine will cost ₹ 2,00,000 with an estimated life of 10 year. Both machine have no residual value. Assume tax rate to be 40%. The annual sales and costs are estimated as below:

Automatic Machine Standard Machine ( ) 250,000 Sales Costs: Materials Labour Variable Overheads 250,000 50,000 20,000 25,000 50,000 100,000 15,000

Calculate the payback period and advice the management.

Answer 1

Automatic Machine
Year	0	1	2	3	4	5	6	7	8	9	10
cost of machine	-350000
sales		250000	250000	250000	250000	250000	250000	250000	250000	250000	250000
less material cost		50000	50000	50000	50000	50000	50000	50000
less labor		20000	20000	20000	20000	20000	20000	20000
less variable overheads		25000	25000	25000	25000	25000	25000	25000
operating profit		155000	155000	155000	155000	155000	155000	155000
less tax-40%		62000	62000	62000	62000	62000	62000	62000
after tax profit or net operating cash flow		93000	93000	93000	93000	93000	93000	93000
payback period = initial investment/after tax profit or net operating cash flow	350000/93000	3.76344086
Automatic Machine
Standard machine
Year	0	1	2	3	4	5	6	7	8	9	10
cost of machine	-250000
sales		250000	250000	250000	250000	250000	250000	250000	250000	250000	250000
less material cost		50000	50000	50000	50000	50000	50000	50000	50000	50000	50000
less labor		100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
less variable overheads		15000	15000	15000	15000	15000	15000	15000	15000	15000	15000
operating profit		85000	85000	85000	85000	85000	85000	85000	85000	85000	85000
less tax-40%		34000	34000	34000	34000	34000	34000	34000	34000	34000	34000
after tax profit or net operating cash flow		51000	51000	51000	51000	51000	51000	51000	51000	51000	51000
payback period = initial investment/after tax profit or net operating cash flow	250000/51000	4.90
	Automatic Mahcine	standard machine
Payback period In years	3.76	4.9
Payback period is low in case of automatic machine so it should be considered for Investment