Question

Section 4

Brady's Burgers is considering purchasing a new deep fryer. The fryer will cost $25,000. The new machine will allow them to make french fries faster to fill demand. Brady's estimates that their extra cash flows from investing in this new machine will be:

Yr 1: $10,000

Yr 2: $14,000

Yr 3: $10,000

What is the payback period of this investment? Assume cash flows will be evenly distributed throughout each year.

Group of answer choices

2.5 years

3 years

2.1 years

1 year

Bubba's Hot Dogs wants to start selling a two-foot-long hot dog. In order to do so, they will need to add a new hot dog roasting machine to their restaurant (the new roaster is 2 feet long). Bubba's is considering investing in two different roasters. They each cost $5,000. Bubba's estimates the following cash flows for each machine:

Machine A: (Year 1: $2,000; Year 2: $3,000; Year 3: $4,000)

Machine B: (Year 1: $2,000; Year 2: $2,000; Year 3: $8,000)

Under the Payback Method (assume it is the only method used), which machine would Bubba's select and why?

Group of answer choices

Bubba's would select Machine A because it has the faster payback period.

Bubba's would select Machine B because it has a higher IRR over 3 years.

Bubba's would select Machine B because it has the faster payback period.

Bubba's would select Machine B because the cash flows in year 3 are higher than for Machine A.

Tommy's Turkey Sandwich Shop is considering expanding the restaurant and buying some new equipment. The investment will allow Tommy's to both increase its sales through a new catering business opportunity and also produce everything less expensively. Tommy's estimates that the investment will cost $100,000. Tommy's has forecast the additional cash flows to its business (resulting from lower costs and increased sales) as follows:

Year 1: $25,000; Year 2: $50,000; Year 3: $100,000

Tommy's has decided it would not make any investments unless the investment earned at least 20.0% over its lifetime.

Should Tommy's make the investment? WHY?

Group of answer choices

No. It does not earn at least 20%.

Yes. It has a positive NPV.

No because it's payback is longer than 2 years.

Yes because it's IRR is under 20%.

Answer 1

Payback period is the time period in which the initial investment is recovered
Year	Cash flows	Cumulative Cash flows
0	-25000	-25000
1	10000	-15000
2	14000	-1000
3	10000	9000
Payback period = 2+ 1000/10,000 = 2.1 years
Machine A
Year	Cash flows	Cumulative Cash flows
0	-5000	-5000
1	2000	-3000
2	3000	0
3	4000	4000
Payback period = 2 years
Machine B
Year	Cash flows	Cumulative Cash flows
0	-5000	-5000
1	2000	-3000
2	2000	-1000
3	8000	7000
Payback period = 2 +1000/8000 = 2.125 years
Bubba's would select Machine A because it has the faster payback period
NPV = Present value of cash inflows - Present value of cash outflows
=-100,000 + 25000/(1.2) +50,000/(1.2)^2 + 100,000/(1.2)^3
=$13,425.93
Yes. It has a positive NPV.