Question

IU Manufacturing plans on purchasing a new assembly machine for $32,000 to automate one of its current manufacturing operations. It will cost an additional $3,500 to have the new machine installed. With the new machine, IU expects to save $12,000 in annual operating and maintenance costs. The machine will last five years with an expected salvage value of $5,000.
1.   How long will it take to recover the investment (plus installation cost)?
2.   If lU’s interest rate is known to be 17%, determine the discounted payback period.

Answer 1

1.

Total cost = 32000 + 3500 = 35500

Payback period = 35500 / 12000 = 2.958333 ~ 2.96 yrs

2.

NPW of first 3 yrs of cash flow = 12000*(P/A,17%,3)

= 12000*2.209585

= 26515.02

Cumulative cash flow = -35500 + 26515.02 = -8984.98

NPW of 4th yr of cash flow = 12000*(P/F,17%,4) = 12000*0.533650 = 6403.8

Cumulative cash flow = -8984.98 + 6403.8 = -2581.18

NPW of 5th yr of cash flow = (12000+5000)*(P/F,17%,5)

= 17000*0.456111

= 7753.89

Discounted payback period = 4 + 2581.18 / 7753.89 = 4.33 yrs