Southern Cola is considering the purchase of a bottling machine for $28,000. The

Question

Southern Cola is considering the purchase of a bottling machine for $28,000. The useful life is expected 7 years with zero terminal disposal price. The plant manager estimates the following savings in cash- operating cost.

Year 1...... 10,000

year 2...... 8,000

year3........ 6,000

year 4........5,000

year 5........4,000

year 6........3,000

year 7........3,000

Southern cola uses a required rate of return of 16% in it's capital budgeting decisions.

1. Compute the payback period

2. Compute net present value

3. should southern cola go ahead with the investment?

Explanation / Answer

Payback period is the time by which undiscounted cashflow cover the intial investment outlay

this is happening between year 3 and 4

there fore payback period = 3 + (0-(-4000))/(1000-(-4000)) = 3.8 years

Donot accept project as NPV is negative

Year Cash flow stream Cumulative cash flow 0 -28000 -28000 1 10000 -18000 2 8000 -10000 3 6000 -4000 4 5000 1000 5 4000 5000 6 3000 8000 7 3000 11000

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