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    Kitchen Shop - Payback/IRR Calculations

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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.)
    Required:

    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) Compute the payback period of the new machine
    Payback period is defined as the expected number of years required to recover the original investment.

    We consider the saving of $8,000 per year to be the expected return of the new machine.

    Payback period = Initial investment/Expected return per year

    Payback period = 41,595/8,000 = 5.20 years

    2) Compute the internal rate of return

    The internal rate of return is defined as that discount rate which equates the present value of a machine's ...

    Solution Summary

    This solution is comprised of a detailed explanation to compute the payback period and the internal rate of return of the new machine.

    $2.19

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