1. The Delta Company is planning to purchase a machine known as machine X.
Machine X would cost
$25,000 and would have a useful life of 10 years with zero salvage value. The expected annual cash
inflow of the machine is $10,000.
Required: Compute payback period of machine X and conclude whether or not the machine would be
purchased if the maximum desired payback period of Delta Company is 3 years.
Answer:
Since the annual cash inflow is even in this project, we can simply divide the initial investment by the
annual cash inflow to compute the payback period.
It is shown below:
Payback period = $25,000/$10,000
= 2.5 years
According to payback period analysis, the purchase of machine X is desirable because it’s payback period
is 2.5 years which is shorter than the maximum payback period of the company
2. Due to increased demand, the management of Rani Beverage Company is considering to purchase a
new equipment to increase the production and revenues.
The useful life of the equipment is 10 years and the company’s maximum desired payback period is 4
years. The inflow and outflow of cash associated with the new
Equipment is given below:
Initial cost of equipment: $37,500
Annual cash inflows:
Sales: $75,000
Annual cash Outflows:
Cost of ingredients: $45,000
Salaries expenses: $13,500
Maintenance expenses: $1,500
Required: Should Rani Beverage Company purchase the new equipment? Use payback method for your
answer.
Answer:
Step 1: In order to compute the payback period of the equipment, we need to work out the net annual
cash inflow by deducting the total of cash outflow from
the total of cash inflow associated with the equipment.
Computation of net annual cash inflow:
$75,000 – ($45,000 + $13,500 + $1,500)
= $15,000
Step 2: Now, the amount of investment required to purchase the equipment would be divided by the
amount of net annual cash inflow (computed in step 1) to
find the payback period of the equipment.
= $37,500/$15,000
=2.5 years
3. Smart Manufacturing Company is planning to reduce its labor costs by automating a critical task that
is currently performed manually. The automation requires the installation of a new machine. The cost to
purchase and install a new machine is $15,000. The installation of machine can reduce annual labor cost
by $4,200. The life of the machine is 15 years. The salvage value of the machine after fifteen years will
be zero.
The required rate of return of Smart Manufacturing Company is 25%. Should Smart Manufacturing
Company purchase the machine?
Answer:
According to net present value method, Smart Manufacturing Company should purchase the machine
because the present value of the cost savings is greater than the present value of the initial cost to
purchase and install the machine. The computations are given below:
4. If most likely is 6, worst case is 10 and best case as 5, calculate
1. Double triangular distribution value
2. Simple Average
3. Standard deviation.
Answers:
DTD= (5+4*6+10)/6= 6.5
SA= 21/3=7
SD=5/6= .8
