Problem:
Brown Company is considering two new machines that should produce considerable cost savings in its assembly operations. The cost of each machine is $15,000 and neither is expected to have a salvage value at the end of a 4-year useful life. Brown's required rate of return is 12% and the company prefers that a project return its initial outlay within the first half of the project's life. The annual after-tax cash savings for each machine are provided in the following table:
Annual After Tax Cash Savings
Year Machine A Machine B
1 $5,000 $8,000
2 5,000 6,000
3 5,000 4,000
4 5,000 2,000
Total $20,000 $20,000
1) Compute the payback period for each machine using the incremental approach.
2) Compute the unadjusted rate of return based on average investment for each machine. The machines will be depreciated on a straight-line basis.
3) Compute the net present value for each machine.
4) Which machine would you recommend? Explain your reasoning.
5) Compute the internal rate of return for Machine A.