12. Heels, a shoe manufacturer, is evaluating the costs and benefits of new equi

Question

12. 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 $105,000 and is expected to generate an additional $40,000 in cash flows for 5 years. A bank will make a $105,000 loan to the company at a 15% interest rate for this equipment’s purchase and 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.)

Required A: Payback Period

Compute the recovery time for the payback period.

Required B: Break even time

Explanation / Answer

Solution A:

Payback period = Initial Investment ÷ Annual Cash Flow = $105,000 ÷ $40,000 = 2.625 years

Solution B:

from above table,it is very clear company is recovering its initial cost in betwwen year 3 & year 4

Break even time = 3 + ($13,671 / $22,870) = 3.60 years

Computation of PV of cash inflow and outflows and comulaitve PV for cash inflow (outflows) Year Cash inflow (Outflow) PV factor Present Value Cumulative Present Value of inflow (outflow) 0 -$105,000.00 1 -$105,000.00 -$105,000.00 1 $40,000.00 0.86957 $34,782.61 -$70,217.39 2 $40,000.00 0.75614 $30,245.75 -$39,971.64 3 $40,000.00 0.65752 $26,300.65 -$13,671.00 4 $40,000.00 0.57175 $22,870.13 $9,199.13 5 $40,000.00 0.49718 $19,887.07 $29,086.20

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