Question

In: Finance

The Dammon Corp. has the following investment opportunities: Machine A Machine B Machine C ($10,000 cost)...

The Dammon Corp. has the following investment opportunities:

Machine A Machine B Machine C
($10,000 cost) ($22,500 cost) ($35,500 cost)
Inflows Inflows Inflows
year 1 $ 6,000 year 1 $ 12,000 year 1 $ -0-
year 2 3,000 year 2 7,500 year 2 30,000
year 3 3,000 year 3 1,500 year 3 5,000
year 4 -0- year 4 1,500 year 4 20,000

Under the payback method and assuming these machines are mutually exclusive, which machine(s) would Dammon Corp. choose?

Multiple Choice

  • Machine A

  • Machine B

  • Machine C

  • Machine A and B

Solutions

Expert Solution

Machine A

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

Payback period= 2 years + ($10,000 – $9,000)/ $3,000

                              = 2 years + $1,000/ $3,000

                              = 2 years + 0.33

                              = 2.33 years.

Machine B

Payback period= $12,000 + $7,500 + $1,500 + $1,500 = $22,500

                              = 4 years

Machine C

Payback period= 3 years + ($35,500 – $35,000)/ $20,000

                              = 3 years + 500/ 20,000

                              = 3 years + 0.025

                              = 3.025 years.

Dammon corp would choose machine A since it has the lowest payback period.

Hence, the answer is option a.

In case of any query, kindly comment on the solution.


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