Question 1183089: A machine is under consideration for investment. The cost of the machine is P25,000.00. Each year it operates, the machine will generate a savings of P15,000.00. Given the effective annual interest rate of 18%, what is the discounted payback period, in years, on the investment of the machine?
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Answer by Theo(13342)   (Show Source):
You can put this solution on YOUR website! the cost of the machine is 25,000.
the machine generates savings of 15,000 annually.
the effective interest rate is 18% per year.
the discounted payback period takes into account that the 15,000 annual savings is less valuable today when it is further out in the future.
a savings of 15,000 today is equal to 15,000 today.
a savings of 15,000 one year from now is equal to 15,000 / 1.18 = 12,711.86 today.
a savings of 15,000 two years from now is equal to 15,000 / 1.18^2 = 10,772.77 today.
taking this into account, you find the discounted payback period is when the cumulative value of the discounted savings becomes greater than the present value of the investment.
this occurs when the cumulative value of the present value of the cash flows becomes positive.
the cash flow shows the investment as negative because it is money going out and shows the savings as positive because it is money coming in.
as shown in the spreadsheet, the cumulative value of the present value of the cash flows becomes positive by the end of year 3.
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