21. Nova Corp. has a WACC of 10%. It is evaluating the purchase of a new machine

Question

21. Nova Corp. has a WACC of 10%. It is evaluating the purchase of a new machine and must choose between two mutually exclusive projects. The first machine, Machine A, requires an initial investment of $14,000 and generates after tax cash flows of $3,000 for each of the next seven years. The second machine, Machine B, requires an initial investment of $21,000 and provides annual after tax cash flows of $4,000 for each of the next 10 years. What is the payback period for each machine? According to the payback method, which machine should the firm buy? Why? 22. a. What drawbacks of using the payback method are illustrated in the previous question? b. What are the positive points of using payback? How can it be helpful to the manager? 23. Paine Corp.

Explanation / Answer

21. Payback for Machine A = 4 + (14000-4*3000)/3000 = 4.67 years Payback for Machine B = 5 + (21000-5*4000)/4000 =5.25 years Based on payback period, Machine A should be chosen as it has lower payback period

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