Question

In a workover job, it is required to purchase a pump. There are in the market two pumps A and B. Pump A has price 300,000 $, annual net cash flow 50, 000 $ and salvage value 200,000$ at the end of 1^st year with annual decrease 20, 000$ and pump B has price 400,000 $, annual net cash flow 80, 000 $ and salvage value 250,000$ at the end of 1^st year with annual decrease 25, 000$. It is planned to use the selected pump for 6 years.

Determine:

Bail-out period of each pump and salvage value

Payout period ignoring salvage value of each pump

Suitable pump for project

Answer 1

Answer :

Pump A-

Price or cost of investment = $300,000

Annual net cash flow= $ 50, 000

Salvage value = $200,000

Annual decrease = $ 20,000

Pump B-

Price or cost of investment = $400,000

Annual net cash flow = $80, 000

Salvage value = $250,000

Annual decrease = $ 25,000

Formula for calculating Bail-out period of each pumps and salvage value =

                  = (Price or cost of investment- salvage value) / annual net cash flow

Formula for calculating Payout period ignoring salvage value of each pump-

= price or cost of the investment / annual net cash flow

Part 1-

• Calculating Bail-out period of pump A-

= ($300,000- $200,000) / $50,000

= $100,000 / $50,000

= 2 years

• Calculating Bail-out period of pump B-

= ($400,000 - $250,000) / $ 80,000

= $150,000 / $80,000

= 1.86 years

Part 2-

• Calculating payout period ignoring salvage of pump A-

= $300,000 / $50,000

= 6 years

• Calculating payout period ignoring salvage of pump B-

= $400,000 / $80,000

= 5 years

Part 3-

• Pump B is suitable pump for project because its payout period (5 years) is shorter than the payout period of A (6 years).

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