5. Churnham and Burnham, LLP is evaluating the purchase of a new computer system

Question

5. Churnham and Burnham, LLP is evaluating the purchase of a new computer system. System A will require an initial outlay of $100,000. Cash inflows are expected to be $10,000 at the end of year one, $20,000 at the end of year two, $30,000 at the end of year three, $40,000 at the end of year four, and $50,000 at the end of year five. System B will require an initial outlay of $50,000, with expected cash inflows of $10,000 at the end of year one, $20,000 at the end of year two, $15,000 at the end of year three, and $20,000 at the end of year four. The firm has a 10% required rate of return (the "hurdle rate"). If Churnham and Burnham, LLP makes its decision using the payback method, which computer system will it acquire? Select one: A. System A. B. System B. C. Neither System A nor System B. D. Cannot be determined from the information provided.

Explanation / Answer

Calculation of payback period Year System A Year System B Cash flow Cumulative Cash flow Cash flow Cumulative Cash flow 0 -$100,000.00 -$100,000.00 0 -$50,000.00 -$50,000.00 1 $10,000.00 -$90,000.00 1 $10,000.00 -$40,000.00 2 $20,000.00 -$70,000.00 2 $20,000.00 -$20,000.00 3 $30,000.00 -$40,000.00 3 $15,000.00 -$5,000.00 4 $40,000.00 $0.00 4 $20,000.00 $15,000.00 5 $50,000.00 $50,000.00 Payback period of System A = 4 Years. Payback period of System B = 3 Years + ($5000/$20000) = 3.25 Years Churnham and Burnham, LLP should aquire System B as it has lower payback period compared to System A. The answer is Option B.

Related Questions

Navigate

• Browse (All)
• Browse 5
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.