Question

ABC Company is evaluating whether to invest in a projects. The project is a robot that will stack the finished goods product on pallets for shipment. Currently, the product is being stacked manually. The robot will cost $1,000,000. The cash inflows for the project are Tear 1: $230,000; Year 2: $180,000; Year 3: $150,000; and Years 4-10: $100,000. Evaluate the investment using the capital budgeting method "Payback Period". The cost of capital for ABC Co. is 8%. Discuss your findings and recommendations.

Answer 1

The payback period is calculated using the below formula:

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                              = 4 years + ($1,000,000 - $960,000)/ $100,000

                              = 4 years + $40,000/ $100,000

                              = 4 years + 0.40

                              = 4.40 years.

The project should not be undertaken if the cut-off period of the project is greater or equal to 4.40 years.