Payback & NPV Examples

N04 HL P1 Q5

Payback Calculation
Year
Machine A $
Machine B $
1
45,000
25,000
Part of 2
20,000 (0.57 of 35,000)
35,000
Part of 3
-
25,000 (0.45 of 55,000)
Investment
65,000
85,000

1 + 0.57 = 1.57 (Machine A has payback period of 1.57 years)
2 + 0.45 = 2.45 (Machine B has payback period of 2.45 years)

Accounting Rate of Return Calculation

Machine A $
Machine B $
Net Return
155,000
205,000
Total Return-Investment
155,000 – 65,000 = 90,000
205,000 – 85,000 = 120,000
Average Return
90,000 / 5 years = 18,000
120,000 / 5 years = 24,000
ARR =
(Average / Investment)
(18,000 / 65,000) x 100 = 28%
(24,000 / 85,000) x 100 = 28%

Net Present Value Calculation
Year
Discount Factor
Machine A $
Machine B $

Cash Flow
Present Value
Cash Flow
Present Value
0
1
(65,000)
(65,000)
(85,000)
(85,000)
1
0.909
45,000
40,905
25,000
22,725
2
0.826
35,000
28,910
35,000
28,910
3
0.751
25,000
18,775
55,000
41,305
4
0.683
25,000
17,075
55,000
37,565
5
0.621
25,000
15,525
55,000
21,735
Total
-
121,190
-
152,240
Net Present Value

56,190

67,240

Machine A has a faster payback period. If Riveau Yachts does not want to take risks such as cash flow problems, it should choose Machine A. Payback period is also more accurate as it is more predictable. However, the net present value calculations shows that Machine B has a higher net present value of returns. Net Present Value is a better method or appraising investments because it takes time value of money into consideration. Thus, choose Machine B.

Assessing financial advantages and disadvantages to investing in each of the machines.

Machine A
Machine A has a faster payback period and therefore, gives Riveau Yachts the advantage of having less risk if they were to have any cash flow problems in the future.
Since Riveau Yachts is a business that makes boats, where said technology progresses fast, having a shorter payback period can