Question

Heels, a shoe manufacturer, is evaluating the costs and benefits of new equipment that would custom fit each pair of athletic shoes. The customer would have his or her foot scanned by digital computer equipment; this information would be used to cut the raw materials to provide the customer a perfect fit. The new equipment costs $117,000 and is expected to generate an additional $45,000 in cash flows for five years. A bank will make a $117,000 loan to the company at a 12% interest rate for this equipment’s purchase. Compute the recovery time for both the payback period and break-even time. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Answer 1

* Payback period: 2.6 years;

* Break-even time: 3.3 years.

Step-by-step explanation:

Please find the below for detailed explanation and calculation:

* Payback period calculation:

Payback period = Initial investment outlay/ annual additional cash flow = 117,000/45,000 = 2.6 yeas;

* Break-even time calculation:

We have the net present value of the project after 3 years is:

-117,000 + (45,000/12%) x ( 1 + 1.12^-3) = $(8,917.6)

Present value of year 4 additional cash flow = 45,000 / 1.12^4 = 28,598

=> Break even time ( years) = 3 + (8,917.6/28,598) = 3.3 years.