Chapter 26, Problem P26.32APGA

Using payback, ARP, and NPV with unequal cash flows

Learning Objectives 2, 4

1. Refurbish $19,810 NPV; Purchase 2.7 years payback

Henderson Manufacturing, Inc. has a manufacturing machine that needs attention The company is considering two options. Option 1 is to refurbish the current machine at a cost of $1,200,000. If refurbished, Henderson expects the machine to last another eight years and then have no residual value. Option 2 is to replace the machine at a cost of $4,600,000. A new machine would last 10 years and have no residual value Henderson expects the following net cash inflows from the two options:

Year	Refurbish Current Machine	Purchase New Machine
1	$ 350,000	$ 3,780,000
2	340,000	510,000
3	270,000	440,000
4	200,000	370,000
5	130,000	300,000
6	130,000	300,000
7	130,000	300,000
8	130,000	300,000
9		300,000
10		300,000
Total	$ 1,680,000	$ 6,900,000

Henderson uses straight-line depreciation and requires an annual return of 10%.

Requirements

1. Compute the payback, the ARR,the NPV, and the profitability index of these two options
2. Which option should Henderson choose?Why?