Question

Carla Vista Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. The firm uses a 7 percent discount rate for their production systems. Year System 1 System 2 0 -$13,200 -$46,200 1 13,200 32,400 2 13,200 32,400 3 13,200 32,400 What are the payback periods for production systems 1 and 2? (Round answers to 2 decimal places, e.g. 15.25.) Payback period of System 1 is years and Payback period of System 2 is years. If the systems are mutually exclusive and the firm always chooses projects with the lowest payback period, in which system should the firm invest? The firm should invest in .

Answer 1

System 1

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

Payback period= The first year produces a cash inflow of $13,200.

So, the payback period is 1 year.

System 2

Payback period= 1 year + $13,800/ $32,400

                              = 1 year + 0.4250

                              = 1.4250 years  

Therefore, the payback period is 1.43 years.

The firm should invest in system 1 since it has the lowest payback period.

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