Question

Heartland Paper Company is considering the purchase of a new high-speed cutting machine. Two cutting machine manufacturers have approached Heartland with proposals: (1) Toledo Tools and (2) Akron Industries. Regardless of which vendor Heartland chooses, the following incremental cash flows are expected to be realized.

Year	Incremental Cash Inflows				Incremental Cash Outflows
1	$	27,000			$	22,000
2		28,000				23,000
3		33,000				28,000
4		36,000				31,000
5		35,000				30,000
6		34,000				29,000

a. If the machine manufactured by Toledo Tools costs $30,000, what is its expected payback period?

b. If the machine manufactured by Akron Industries has a payback period of 60 months, what is its cost?

c. Which of the machines is most attractive based on its respective payback period?

Answer 1

Payback period is the time period in which the initial investment is recovered
Year	Net Cash flows	Cumulative cash flows
0	(30,000)	(30,000)
1	5,000	(25,000)
2	5,000	(20,000)
3	5,000	(15,000)
4	5,000	(10,000)
5	5,000	(5,000)
6	5,000	-
Payback period = 6 years i.e. 72 months
b.Cost = 5000*5 = $25,000
c.Machine manufactured by Akron Industries is attractive as lower payback period