Question

X Company must replace one of its current machines with either Machine A or Machine B. The useful life of both machines is seven years. Machine A costs $50,000, and Machine B costs $58,000. Estimated annual cash flows with the two machines are as follows: Year von AWN- Machine A $-6,000 -8,000 -8,000 -8,000 -6,000 -5,000 -4,000 Machine B $-7,000 -4,000 -3,000 -3,000 -3,000 -2,000 -2,000 If X Company buys Machine B instead of Machine A, what is the payback period in years)?

Answer 1

Initial Cash out flow	58000
Cost of the machine B	Recoverable amount (a)	Cash inflow (b)	Balance recoverable amount a-b
Year 1	58000	7000	51000
Year 2	51000	4000	47000
Year 3	47000	3000	44000
Year 4	44000	3000	41000
Year 5	41000	3000	38000
Year 6	38000	2000	36000
Year 7	36000	2000	34000
Pay back period is the year when the balance recoverable becomes zero
In the current scenario the machine is not paying back what amount is invested. Hence there is no pay back period. It is not adivasble to replace with machine B since only 34000 is recovered from the useful life of the machine
Pay back period is 7 years and not complete amount is recovered in 7 years