Question

SohnCo. Baby Products Division that is thinking about investing in tooling for injection molding for their line of collegiate baby bottles. This tooling will cost $300,000. The tooling will save an estimated $150,000 per year for 5 years. Assume MACRS depreciation for the tools and a 30% income tax. SohnCo. uses an after-tax MARR of 12%.

a) What is the payback period for SohnCo.?

b) Is this investment justifiable? Why?

Answer 1

Answer : Calculation of Payback Period

(a.)Payback Period = Initial Investment / Annual Cash Flows

= 300000 / 150000

= 2 years

(b.) To estimate whether investment is Jusifiable we need to estimate NPV of the Project

NPV = Present Value of Cash Inflow - Presesent Value of Cash Outflow

= Total of Discounted Cash Flows - 300,000

= 442303.7853 - 300000

= 142303.7853

Since NPV is positive therefore Investment is Justified.

Below is the table showing Present Value of Cash Inflow for 5 Years

	1	2	3	4	5
Savings (A)	150,000	150,000	150,000	150,000	150,000
(-) Depreciation (Refer Working Note) (B)	60,000	96,000	57,600	34,560	34,560
Earnings Before Taxes (C) = (A) - (B)	90,000	54,000	92,400	115,440	115,440
(-)Taxes @ 30% [ D = (C) *30%]	27,000	16,200	27,720	34,632	34,632
Earnings After Taxes (E) = (C) - (D)	63,000	37,800	64,680	80,808	80,808
(+) Depreciation ( Non cash Item) (B)	60,000	96,000	57,600	34560	34560
Annual Cash Flows (F) = (E) + (B)	123,000	133,800	122,280	115,368	115,368
PVF @12%	0.892857	0.797194	0.711780	0.635518	0.567427
Dicounted Cash Flows	109821.411	106664.5572	87036.4584	73318.4406	65462.9181

Working Note :

Cost = $300,000

Belows is the table showing Depreciation

	1	2	3	4	5
Depreciation (Cost*Rate )	300000 *20% = 60,000	300000*32% =96,000	300000*19.2% =57,600	300000 * 11.52% =34560	300000 * 11.52% =34,560