Question

After many years of operation, the owner of a machine shop would like to shut down his business in the year 2022. Until then, he needs to replace a worn-out machine due to frequent breakdowns and high maintenance cost. The table below shows the decision criteria for three potential replacement machine types.

Machine A		Machine B		Machine C
Payback period	3 years		5 years		4 years
Simple rate of return	10%		11%		10%
Net present value	3,958		2,592		4,950
Internal rate of return	11 – 12%		15 – 16%		10 – 11%

Using at least two decision criteria, which machine would you recommend, and why?

Answer 1

Answer::

Machine	A	B	C
Payback period	3 years	5 years	4 years
Simple rate of return	10%	11%	10%
Net present value	3,958	2,592	4,950
Internal rate of return	11 – 12%	15 – 16%	10 – 11%

Machine that should be selected as per the different criteria are marked in green.

Payback period:Payback period is the period in which you will get the outflow of money back. Thus the lower it is the better it is. Hence machine A should be selected.

Simple rate of return: It is calculated as returns over the net capital employed.Thus, the highest rate of return is of the machine B.So, according to this criteria machine B should be selected.

NPV: NPV represents the present value of inflows minus outflows. Thus a project with the higher present value should be selected. Machine C is worth more value.

IRR:: Higher the IRR better it is. Thus as per this criteria machine B should be selected.

Since two criteria indicate that machine B performs better in terms of cash flows. Machine B is the best choice.