Question

1.       Choo Choo Inc. is a manufacturer of model trains. The company is considering the purchase of an industrial 3D printer, which will allow the firm to produce custom-made model trains for its high-end customers. The printer will cost $1,000,000, and it is expected to produce net cash flows of $350,000 per year for the next six years. Liquidation of the equipment will net the firm $100,000 in cash at the end of six years. The firm requires a 13% rate of return on all investments. Ignore the effects of taxes.

a. What is the payback period for the proposed investment in the 3D printer? Provide your answer in number of years and months.   

b. What is the printer’s discounted payback period? Provide your answer in number of years and months.   

c. Choo Choo’s cutoff period is set at three years. Based on the payback period investment criterion, will the company purchase the printer? Will it purchase the printer based on the discounted payback period investment criterion? (1 mark)

d. What is the printer’s net present value (NPV)? Should the company purchase the printer based on the NPV investment criterion?

e. What is the printer’s profitability index (PI)? Should the company purchase the printer based on the PI investment criterion?   

f.   What is the printer’s internal rate of return (IRR)?   

g. Check that at the internal rate of return (IRR) the net present value of the printer is $0. Should the company purchase the printer based on the IRR investment criterion?  

h. Based on your answers in parts a-f above, what decision do you recommend for Choo Choo?

Answer 1

As per rules I am answering the first 4 subparts of the question.

A: Payback = 2.86 years = 2 years and 10.32 months

B: Discounted payback = 3.81 years = 3 years and 9.72 months

C: Based on payback, it will purchase the printer since the payback is lesser than 3 years. Based on discounted payback, it will not purchase the printer since the payback is more than 3 years.

D: NPV = 447174.28

Since NPV is positive, the printer should be purchased.

Workings

Payback = Year in which Cumulative CF is last negative -(Last negative cumulative CF/ CF of next year
Discounted Payback = Year in which Discounted Cumulative CF is last negative -(Last negative discounted cumulative CF/ CF of next year)

Year	Initial cost	Cash flows	Terminal value	Net cash flows	Cumulative CF		Discounted CF	Cumulative DCF
0	-1000000			-1000000	-1000000		-1000000	-1000000
1		350000		350000	-650000		309734.5133	-690265.4867
2		350000		350000	-300000		274101.3392	-416164.1475
3		350000		350000	50000		242567.5568	-173596.5907
4		350000		350000	400000		214661.5547	41064.96394
5		350000		350000	750000		189965.9776	231030.9415
6		350000	100000	450000	1200000		216143.3373	447174.2789

Excel formulae