Exercise 1: Name And Account 600 - Accounting And Finance Fo

Exercise 1namenameacc 600 Accounting And Finance For Managersassig

Exercise 1namenameacc 600 Accounting And Finance For Managersassig

Using payback to make capital investment decisions White Co. is considering acquiring a manufacturing plant. The purchase price is $1,350,000. The owners believe the plant will generate net cash inflows of $329,000 annually. It will have to be replaced in six years. Instructions Use the payback method to determine whether White should purchase this plant. Round to one decimal place. Payback = Formula in words = #s for formula = Calculation using Excel formula Should White purchase this plant? Why or why not?

Paper For Above instruction

Investing in new capital assets is a crucial decision for any organization, as it directly affects its long-term profitability and operational capacity. One of the fundamental methods used to evaluate such investments is the payback period method, which determines the amount of time needed for an investment to generate cash inflows sufficient to recover its initial cost. This method is straightforward and emphasizes liquidity and risk assessment, making it valuable for managerial decision-making processes.

In the case of White Co., the potential acquisition of a manufacturing plant involves a purchase price of $1,350,000, with an expected annual net cash inflow of $329,000. The primary question is whether this investment is financially justified based on the payback period criterion. The plant is to be replaced after six years, which suggests that the investment horizon is six years, and the payback method can provide a clear answer if the payback period falls within or before this period.

Calculating the Payback Period

The payback period is calculated by dividing the initial investment by the annual cash inflows. In words, the formula is:

Payback Period = Initial Investment / Annual Cash Inflows

Translating this into an algebraic formula:

Payback Period = \$1,350,000 / \$329,000

Using Excel, the formula to compute this would be:

=1350000/329000

Performing the calculation yields:

= 4.1 years

This means the investment will be recovered in approximately 4.1 years, which is within the plant’s six-year replacement cycle. The payback period suggests that the project is financially viable from a liquidity perspective, as the initial investment is recovered in less than six years.

Should White purchase this plant? Why or why not?

Based on the payback period analysis, White Co. should consider purchasing the plant. The payback period of approximately 4.1 years indicates that the organization would recoup its initial investment well within the six-year lifecycle of the plant. This short recovery period reduces long-term risk, especially considering potential changes in market conditions, technological advancements, or other uncertainties.

While the payback method emphasizes liquidity and risk mitigation, it does not account for the time value of money or the profitability beyond the payback point. Therefore, it should be supplemented with other financial evaluation methods such as Net Present Value (NPV) or Internal Rate of Return (IRR) for a comprehensive analysis.

In conclusion, the payback approach provides a quick, clear indication that this investment is financially sound given the rapid recovery of the initial capital. If White Co.’s strategic focus is on minimizing risk and ensuring liquidity, the acquisition of this manufacturing plant appears to be a sound decision.

References

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  • Investopedia. (2023). Payback Period Definition. https://www.investopedia.com
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