9-10.6 Blanda Incorporated management is considering investing in two alternativ

Question

9-10.6

Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 10 percent discount rate for their production systems. What are the payback periods for production systems 1 and 2? (Round answers to 2 decimal places, e.g. 15.25.) If the systems are mutually exclusive and the firm always chooses projects with the lowest payback period, in which system should the firm invest?

Explanation / Answer

Solution:

System 1 has payback period of exactly one year because the initial investment of $15,700 is recovered in one year.

Payback period =1 + (-11,700)/33,200

Payback period = 1.35 years

The firm should invest in system 2 because it has the lowest payback period.

Year System 2 Cumulative CF 0 -44,900 -44,900 1 33,200 -11,700 2 33,200 21,500 3 33,200 54,700

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