A \"power saving\" air conditioning system is being considered. It is estimated

Question

A "power saving" air conditioning system is being considered. It is estimated to cost $5,000 more than the inefficient system and expected to save $ 1,300 per year in power costs. If the firm has a target ROI value of 12%, determine the payback using the incorrect method that does not consider TVM. Next, calculate the correct payback period using TVM techniques. Is this a reasonable expectation? If, under actual use, the system only saves $300 per year in power costs, how long will it take for the system to pay for itself? Is this a reasonable time period?

Explanation / Answer

Solution.

Calculation of Payback period through incorrect method.

P.B.P = 3 + (1,100 / 1,300 ) = 3.84 year.

2. Calculation of Payback period through correct method.

P.B.P = 5 + ( 314.15 / 658.58 ) = 5.47 year

Year Cash Inflow Cumulative inflow 1               1,300               1,300 2               1,300               2,600 3               1,300               3,900 4               1,300               5,200 5               1,300               6,500

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