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 $48,000, and Machine B costs $56,000. Estimated annual cash flows with the two machines are as follows: Year Machine A Machine B 1 $-6,000 $-7,000 2 -8,000 -4,000 3 -8,000 -3,000 4 -8,000 -3,000 5 -6,000 -3,000 6 -5,000 -2,000 7 -4,000 -2,000 If X Company buys Machine B instead of Machine A, what is the payback period (in years)?

Answer 1

Solution:

Year	Cash Flows (Machine A)	Cash flows (Machine B)	Difference	Cumulative Differences
1	-6000	-7000	-1000	-1000
2	-8000	-4000	4000	3000
3	-8000	-3000	5000	8000
4	-8000	-3000	5000	13000
5	-6000	-3000	3000	16000
6	-5000	-2000	3000	19000
7	-4000	-2000	2000	21000

Difference in Investment
Cost of Machine B	56000
Cost of Machine A	48000
Difference in investment	8000

Payback period = 3 years (as the total differential investment is recovered in 3 years)