The small drilling machine in the job shop is worn beyond repair. The supervisor has done some research and found that any of the three Makes A, B, or C will suffice as a replacement. The cashflows for these three candidate machines are given as follows.If the company funds projects of payback

Question

The small drilling machine in the job shop is worn beyond repair. The supervisor has done some research and found that any of the three Makes A, B, or C will suffice as a replacement. The cashflows for these three candidate machines are given as follows.If the company funds projects of payback periods only under 3 years, which one should be selected?

Make C	Make B	Make A	Year
-$9,000	-$7,000	-$5,000	0
$4,000	$3,000	$2,000	1
$3,750	$2,500	$2,000	2
$3,500	$2,000	$2,000	3
$3,250	$1,500	$2,000	4
$3,000	$1,000	$2,000	5
$2,750	$ 500	$2,000	6

Accepted Answer

The cash inflows are assumed to be net incomes. We need to follow the two-step procedure of evaluating the payback period of each make, and selecting the one with the shortest payback period provided it is less than 3 years.

[latex]Make A[/latex] :

Using the standard equation, since incomes are constant, the payback period for Make A is:

[latex]={\$5,000}/{(\$2,000 per day)}[/latex]

= 2.5 years

[latex]Make B[/latex]

For Make B, the incomes are variable. So, use either the tabular or graphical method; both involve evaluation of cumulative income. Following the procedure outlined in Example 5.2 or 5.3, the payback period for this make is:

[latex]=2+{(7,000-5,500))}/{2,000}[/latex]

= 2.75 years

[latex]Make C[/latex]

For this make too, the incomes are variable. So, use either the tabular or graphical method (Examples 5.2 and 5.3). The payback period for Make C is:

[latex]=2+{(9,000-7,750)}/{3,500}[/latex]

= 2.36 years

Since all the three makes satisfy the set cut-off payback period of 3 years, each one is worthy of selection. However, on the basis of shortest payback period, Make C is selected.

Question 5.5: The small drilling machine in the job shop is worn beyond re...

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