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    Payback and Internal Rate of Return

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    Unifying Concepts: Payback and Internal Rate of Return
    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.)

    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

    1. Payback period is the time taken to recover the initial investment. The initial investment in the drill press is $41,595. This investment is recovered through the cost savings of $8,000 per year. In 5 years, there will be a total savings of $40,000, leaving $1,595 to be recovered in the sixth year. In the 6th year, the total savings is $8,000. Time taken to generate a savings of $1,595 is 1,595/8,000=0.2 years. The payback period is 5.2 years.

    2. The ...

    Solution Summary

    The solution explains how to calculate payback period and internal rate of return