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    Buy vs Lease scenario

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    The management of Kitchen Shop is thinking of buying a new drill press to aid in adapting parts for different machines. The press is expected to save Kitchen Shop $8,000 per year in costs. However, Kitchen Shop has an old punch machine that isn't worth anything on the market and that will probably last indefinitely. The new press will last 12 years and will cost $41,595.
    (Ignore income tax effects.)

    I would like understand how to compute the following:

    1. Compute the payback period of the new machine.

    2. Compute the internal rate of return.

    3. Interpretive Question: What uncertainties are involved in this decision? Discuss how they might be dealt with.

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    Solution Preview

    Here are your answers.

    1. The payback period is the time you need in order to recover the investment on a project. In this case, the new drill costs $41,595, and provides an annual inflow of $8,000 (as it saves $8,000 per year in costs). The formula for the payback period is:

    Total Cost
    Annual Inflow

    In this case, it's 41,595/8,000 = 5.19 years. That is, after 5.19 years, this machine ...