Question 17.18: Your company is looking at purchasing a front-end loader at ...
Your company is looking at purchasing a front-end loader at a cost of $120,000. The loader can be billed out at $95.00 per hour. It costs $30.00 per hour to operate the front-end loader and $25.00 per hour for the operator. The useful life of the equipment is five years.
Using 1,200 billable hours per year and a MARR of 20%, determine the payback period with interest for the front-end loader. Does the front-end loader generate enough revenue to recover the initial cost while providing a return of at least 20%?
The hourly profit on the loader equals the billing rate less the operation cost and the cost of the operator and is calculated as follows:
\text { Hourly Profit }=\$ 95.00 / hr -\$ 30.00 / hr -\$ 25.00 / hr
\text { Hourly Profit }=\$ 40.00 / hr
The annual profit on the loader equals the hourly profit times the number of billable hours per year and is calculated as follows:
\text { Annual Profit }=(\$ 40.00 / hr )(1,200 hr / yr )=\$ 48,000 / yr
Convert the annual profits to their present values. The present value of the annual profits is determined by using Eq. (15-3) as follows:
P=\frac{F}{(1+i)^{n}} (15-3)
\begin{array}{l}P_{0}=-\frac{\$ 120,000}{(1+0.20)^{0}}=-\$ 120,000 \\P_{1}=\frac{\$ 48,000}{(1+0.20)^{1}}=\$ 40,000 \\P_{2}=\frac{\$ 48,000}{(1+0.20)^{2}}=\$ 33,333 \\P_{3}=\frac{\$ 48,000}{(1+0.20)^{3}}=\$ 27,778 \\P_{4}=\frac{\$ 48,000}{(1+0.20)^{4}}=\$ 23,148 \\P_{5}=\frac{\$ 48,000}{(1+0.20)^{5}}=\$ 19,290\end{array}
The payback period with interest for purchase of the loader is four years because in the fourth year the present value of the net cash flows to date (–$120,000 + $40,000 + $33,333 + $27,778 + $23,148 = $4,259) is positive for the first time.
Because the payback period is less than the five-year useful life of the loader, the purchase of the loader will generate enough return to recover the initial costs plus interest on the initial investment at an interest rate greater than 20%.
Because interest was included, the payback period of the loader has increased from the three years in Example 17-16 to four years.