Question

Bardoo Inc. is looking at replacing some equipment in one of its plants. Relevant data to the purchase of the equipment is as follows :

Cost of the equipment $320,000

Annual saving provided by the new equipment 60,000

Salvage value of the old equipment 30,000

Expected life of the new equipment 8 years

Required:

1. The owner of Bardoo would like to recoup his original investment in less than five years. Compute the payback period for the investment. Would you recommend that the equipment be purchased? Provide a brief explanation as to your recommendation.

Answer 1

The payback period for the investment

The payback period for the investment = Net Initial investment Cost / Annual cash inflow

= [Cost of the equipment - Salvage value of the old equipment] / Annual cash inflow from the new equipment

= [$320,000 - $30,000] / $60,000

= $290,000 / $60,000

= 4.83 Years

DECISION

YES. Bardoo Inc should purchase the equipment, since the Payback period for the Project (4.83 Years) is less than the maximum allowable payback period (5.00 Years or less).