Question

Abner Ltd that operate in the automobile industry is considering replacing a machine with a new one that requires a R4 200 000 investment. The operating cash inflows over the next 9 years will be R740 000 per annum and the cash inflow for the 10th year will be R220 000. Thereafter the machine will be sold for R400 000. The company uses straight-line depreciation. The cost of capital for projects of similar risk is 11%

Required: If an acceptable payback period is 6 years, determine the payback period and state if the investment is acceptable or not

Answer 1

The payback period for Abner Ltd's investment in a new machine is slightly less than 6 years when summing up the annual cash inflows, thus making the investment acceptable according to the company's criterion of a 6-year acceptable payback period.

Step-by-step explanation:

Abner Ltd is deliberating on whether to replace an existing machine with a new one that entails a R4 200 000 investment. The decision heavily depends on the evaluation of the payback period, which indicates how long it will take for the investment to be recouped through cash inflows generated by the new machine.

To calculate the payback period, we sum the annual cash inflows until we reach the initial investment amount. For Abner Ltd, the annual inflow is R740,000 for the first 9 years and R220,000 in the 10th year, with an additional R400,000 from the sale of the machine at the end of its useful life.

Here's how it's calculated:

1. Years 1-6: The total inflow is R740,000 x 6 = R4,440,000.
2. At the end of the 6th year, the inflows surpass the initial investment of R4,200,000.

Therefore, the payback period is slightly less than 6 years, which means the investment meets the company's acceptable payback period criteria and is considered acceptable.