In: Finance
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
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.