Question

1. Your boss has told you to evaluate the cash flows for Machine 1 and Machine 2, using the payback period method. Which machine are you going to recommend? Justify your answer. YearlMachine 1Machine 2 ) (52,550) (40,000) 10,000 9,000 2 10,1009,025 3 10,450 9,030 4 22,000 9,045 5 20,000 9,099

Answer 1

Payback period

Year	Machine 1	Commulative cash inflow	Machine 2	Commulative cash inflow
0	-52550		-40000
1	10000	10000	9000	9000
2	10100	20100	9025	18025
3	10450	30550	9030	27055
4	22000	52550	9045	36100
5	20000	72550	9099	45199

Machine 1 is able to cover entire cash outflow in 4th year, hence, payback period for Machine 1 is 4 years

Machine 2, It is clearly visible from the commulative cash inflows that, Machine 2 takes slightly more than 4 years to cover its cash outflow.

Now, Payback period of Machine 2

Cash flow for 4 years = 36,100

Balance outlay = 40,000 - 36,100 = 3,900

Therefore payback period = 4 years + 3,900 / 9,099 = 4.43

Since, payback period of Machine 1 is less than Machine 2, Machine 1 should be recommended