Lenox is considering the purchase of a new machine for use in its operations. Ma

Question

Lenox is considering the purchase of a new machine for use in its operations.

Machine A costs $30,000 and has cash flows of $15,000, $10,000, $5,000, and $15,000 respectively for years 1, 2, .3 and 4.

Machine B costs $30,000 and has cash flows of $5,000, $10,000, $15,000, and $15,000 respectively for years 1, 2, .3 and 4.

Management has concluded that since both machines have the same profitability and the same cash flow, it makes no difference which machine is purchased. Is the payback the same on both machines? What other capital budgeting method might be more appropriate? Criticizes management's comments.

Explanation / Answer

Machine A Year Cash Flow Cumulative 0 -30000 -30000 1 15000 -15000 2 10000 -5000 3 5000 0 4 15000 15000 The Payback period is 3 years Machine B Year Cash Flow Cumulative 0 -30000 -30000 1 5000 -25000 2 10000 -15000 3 15000 0 4 15000 15000 The Payback period is 3 years Yes the Payback period is same for both the Machines The other Capital Methods are 1) NPV = Net Present Value Method NPV = Present Values of Cash nflows- Cash Outflows 2) IRR= Internal Rate of return The Rate at which the Net Present Value is Zero 3) Profitability Index Method PI = Present Values of Cash Inflows/ Cash Outflows

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