Question

Cindi Collins has recently been investigating potting machines for her Gondwana Nursery business as a way to reduce labour costs. Cindi comes to you with two options for potting machines; Machine A and Machine B. Machine A costs $60,000 and will bring a reduction in cash outflows of $15,000 for each of the next five years. At the end of that time, Machine A is expected to have a residual (salvage) value of $1,500. Machine B costs $40,000 and is expected to have a residual (salvage) value of $20,000 at the end of five years. Machine B will bring a reduction in cash outflows of $10,000 for each of years 1, 2 and 3, then a reduction in cash outflows of $2,000 in each of years 4 and 5. Gondwana Nursery’s required rate of return on investments is 8%.

(1) Calculate the payback period for options A and B. (show all working)

(2) Calculate the Net Present Value (NPV) for options A and B. (Use the present value discount factors)

Answer 1

Payback period:
Machine-A: Initial Investment / Annual cash inflows
	60000 /15000 = 4 years
Machine-B:
Year	Cash flows	Cumulative cash inflows
0	-40000	($40,000)
1	10000	($30,000)
2	10000	($20,000)
3	10000	($10,000)
4	2000	($8,000)
5	2000	($6,000)
Payback period is 5 years (as the investment wiwll be realised from salvage value only)
Net Present value:
Machine-A
Year	Cash flows	PVF @ 8%	Present value
0	-60000	1	-60000
1	15000	0.925926	13888.89
2	15000	0.857339	12860.08
3	15000	0.793832	11907.48
4	15000	0.73503	11025.45
5	16500	0.680583	11229.62
Net Present value:			911
Machine-B
Year	Cash flows	PVF @ 8%	Present value
0	-40000	1	-40000
1	10000	0.925926	9259.259
2	10000	0.857339	8573.388
3	10000	0.793832	7938.322
4	2000	0.73503	1470.06
5	22000	0.680583	14972.83
Net Present value:			2214