Question

The plant manager of Shenzhen Electronics Company is considering the purchase of new automated assembly equipment. The new equipment will cost $1,400,000. The manager believes that the new investment will result in direct labor savings of $350,000 per year for 10 years.
a. What is the payback period on this project?
b. What is the net present value, assuming a 10% rate of return? c. What else should the manager consider in the analysis?

Answer 1

Answer:

The Payback period of the Investment of $1.4m = $ years

Net Present Value (NPV) = $750,598.00.

Explanation:

The payback period is the expected number of years it will take for a company to recoup the cash it invested in a project.

Net present value (NPV) of a project represents the change in a company's net worth/equity that would result from acceptance of the project over its life. It equals the present value of the project net cash inflows minus the initial investment outlay. It is one of the most reliable techniques used in capital budgeting because it is based on the discounted cash flow approach.

When net cash flows are even as in the example, i.e. when all net cash flows are equal use the formula:

NPV = R ×   1 − (1 + i)-n/i − Initial Investment    

In the above formula:

R is the net cash inflow expected to be received in each period;

i is the required rate of return per period (i.e. the hurdle rate, discount rate);

n are the number of periods during which the project is expected to operate and generate cash inflows.

Therefore, substituting for the figures in the equation =

Where:

Initial Investment = $1,400,000.00

R = $350,000.00

i = 10%

n = 10years

∴ Apply the formula

NPV = R ×   1 − (1 + i)-n/i − Initial Investment    

NPV = $350,000.00 x 1 - (1 + 0.10)${-10}$/0.10 - $1,400,000.00

NPV = $350,000.00 x 1 - (1.10)${-10}$${-10}$/0.10 - $1,400,000.00

NPV = $350,000.00 x 1 - (0.385543/0.10) - $1,400,000.00

NPV = $350,000.00 x 1 - 0.385543/ 0.10 - $1,400,000.00

NPV = $350,000.00 x 0.6144567/0.10 - $1,400,000.00

NPV = $350,000.00 x 6. 144567 - $1,400,000.00

NPV = $2,150,598.00 - $1,400,000.00

NPV = $750,000.45