Question

Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of...

  1. Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of $14,000 and generates annual after-tax cash inflows of $3,000 for each of the next 7 years. The second machine requires an initial investment of $21,000 and provides an annual cash inflow after taxes of $4,000 for 20 years.

    1. a) Determine the payback period for each machine. 


    2. b) Comment on the acceptability of the machines, assuming that they are independent projects. 


    3. c) Which machine should the firm accept? Why? 


    4. d) Do the machines in this problem illustrate any of the weaknesses of using payback? Discuss.

Homework Answers

Answer #1
Req a:
Payback periord = Investment/ Annual cashflows
First machine = 14000 /3000 = 4.33
Second machine = 21000 / 4000 = 5.25
Onnly with minimum criterion of 5yrs, First machine shall be accepted
First machine shall be accepted
The payback period does not take in to consideration, the post payback cashflows generated by the machines
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