Traditionally, Granite Company has accepted a proposal only if the payback period is less than 50 percent of the asset’s useful life. Peggy Casteel is the new accounting manager. She suggested to management that capital budgeting decisions should not be made based solely on the payback period. Granite Company is currently considering purchasing a new machine for the factory that would cost $112,000 and would be sold after 8 years for $50,000. The new machine will generate annual cash flows of $30,000 in its first year of use, $24,000 in its second year of use, $20,000 in the third year, and $14,800 each year thereafter. The company’s cost of capital is 12 percent.

1. Would Granite Company accept this project based solely on the payback period? Why or why not?
2. Would Granite Company accept this project if the NPV method is used to evaluate the machine? Why or why not?
3. What is the likely cause of the difference between your answers for requirement 1 and requirement 2? What type of advice would you provide to management regarding this difference?
4. Without making any computations, if the company’s cost of capital was 10 percent, how would this impact the NPV analysis?

  • CreatedFebruary 27, 2015
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