For the new equipment purchase how do you calculate  the Payback calculation and advise if the equipment will pay itself back within the required timeframe which is 4 years.

Riley Jones, Manager-In-Charge of Manufacturing and Fabrication (Manager 2), has a request related to cash flow-related business decisions. Riley Jones is keen to purchase new fabrication equipment which is much safer to operate, more energy efficient and, therefore, can potentially complete specific key fabrication jobs more economically. The cost reduction is expected make fabrication jobs more affordable, leading to lead to an expanded customer base and, consequently, increased sales.

Riley Jones is preparing a business case to support the acquisition of the new equipment and expansion of the customer base but needs your calculations, advice on cash-flow, and an explanation of the tax implications relating to the proposal.

Manager 2 (Riley Jones) has provided the following information:

1. Expansion of customer base with credit sales

This manufactured product is sold on a Cash On Delivery (COD) basis. Monthly sales are currently $150,000, and cost of goods sold is 70% of sales. The new equipment is expected to reduce cost of goods sold to 60%. Customers will no longer be required to pay COD and will be given credit terms of 30 days. This is expected to increase sales to $250,000 per month.

It is expected sales will be collected in the following pattern:

• 20% of customers will pay at the end of one month
• 25% of customers will pay at the end of 2 months
• 30% of customers will pay at the end of 3 months
• 20% of customers will pay at the end of 4 months
• 5% - of customers will become bad debts

Cost of capital per month is 1%.

1. Acquisition of new equipment

The new equipment must pay back FAB Plastics within 4 years. The information  below outlines the payback result, which will be included in the acquisition proposal.

Calculation	Result
Cost	$4,100,000
Residual value	$0
Useful life	5 years
Depreciation method	Straight line
Expected net cashflows:
Year 1:	$1,200,000
Year 2:	$1,200,000
Year 3:	$1,100,000
Year 4:	$1,000,000
Year 5:	$1,000,000

Answer rating: 100% (QA)

Based on the information provided I have calculated the payback period for the new equipment purchas... View the full answer