LASANI Stone Crushing company is considering to purchase a new machine. The cost of the machine is $360,000 and the life of the machine is 10 years. The machine will reduce annual costs by $75,000.
The management uses payback period method to evaluate capital investments because the quick recovery of any capital investment is very important for the company.
Compute the payback period for this proposal. Would the company purchase new machine if maximum desired payback period of the management is 4 years?
Computation of payback period:
The cost saving of the machine is even (i.e., same amount of cost savings each year). The payback period can therefore be easily computed using payback period formula:
Payback period = Investment required to purchase the machine/Net annual cost savings
= 4.8 years
The payback period of the machine is 4.8 years which is longer than the desired payback period of the company. The machine would therefore not be purchased.