Question

Your company evaluates proposals using a 2.5-year payback period.   You have two alternatives for a new boring machine. Alt. A costs $10,000 and will last for six years.   Alt.A will save $5,000 in year one and $2,000 in year two.   Alt. B will cost $15,000 and will last for six years. Alt.B will save $7,000 in year one and $1,000 in year two.   

(a) What savings in year 3 is needed to make Alt.A an acceptable project?

(b) What savings in year 3 is needed to make B an acceptable project?

(c) If you believe that the year 3 savings will be $7,000 for A and $9,000 for B, which will you buy?

Answer:  (a)________________; (b)___________________;(c)_______________________

Answer 1

Req a:
Acceptable Ppayback period: 2.5 years
Project A
Initial investment					10000
Less: Inflows recovered on first 2 years					7000
Cash inflows remain to be recovred in half year					3000
Hence, Cash inflows in Third year shall be:					6000
		(3000/0.5 year)
Req b:
Project B
Initial investment					15000
Less: Inflows recovered on first 2 years					8000
Cash inflows remain to be recovred in half year					7000
Hence, Cash inflows in Third year shall be:					14000
		(7000/0.5 year)
Req c:
Payback period of A: 2 years + 3000/7000 = 2.43 years
Payback of B: 2 years + 7000/9000= 2.78 years
As payback of Project A is lesser,
Project A shall be accepted