A.

Pay-back period method :

1 Statement showing annual cash inflows :

Particulars Machine M
Original investment 9,000
Estimated life of machine - years 4

Estimated savings in scrap 500

Estimated savings in direct wages 6,000
Total savings - 1 6,500
Additional cost of maintenance 800
Additional cost of supervision 1,200
Total additional costs - 2 2,000
Net Cash Inflow = (1 - 2) 4,500

Pay-back period = Original investment / Annual Average Cash Inflow 2

(Machine M has a shorter pay-back, hence it should be preferred over Machine N.)

2 Statement showing the Net cash flow of three machines :

Particulars Machine 1
Capital Cost 300,000
Economic life - years 2
Scrap value 40,000
Interest on capital 8%

Sales 500,000
Cost of Production 150,000
Administration Cost 20,000
Selling and Distribution Cost 10,000
Total Cost - 1 180,000
Profit before depreciation and interest 320,000
Depreciation : Cost less scrap value / Economic life 130,000
Interest on borrowings 24,000
Depreciation and Interest 154,000
Profit before tax 166,000
Taxation (50%) 83,000
Profit after tax 83,000
Add : depreciation 130,000
Net Cash Inflow 213,000
Pay-back period - years 1.41
Note : Machine 1 is more profitable.

B The Net Present Value (NPV) Method :

Machine A
3 Initial cost 400,000
Additional working capital at the end of 1st year 20,000

Year Cash inflow

1 40,000
 2 120,000
3 160,000
4 240,000
5 160,000
Total present value of cash inflows 720,000
Total present value of cash outflows
Net Present Value
Note : Machine B is preferable to Machine A.

4 Pay-back period method : Project I

Initial investment 50,000

Year Cash inflow

1 25,000
2 15,000
3 10,000
4 0
5 12,000
6 6,000
Pay-back period
Note : Project I has to be preferred over Project II.

Discounted Cash Flow Method : Project I

Initial investment 50,000
Year Cash inflow
1 25,000
2 15,000
3 10,000
4 0
5 12,000
6 6,000
Total present value of Future Cash Inflows :
Net Present Value
Note : In this method Project II is preferred.
(Because under Pay-back period, the return after the pay-back period is ignored)
 Machine N
18,000
5

800
8,000
8,800
1,000
1,800
2,800
6,000

Machine 2 Machine 3
300,000 300,000
3 3
25,000 30,000
8% 8%

400,000 450,000
130,000 142,000
10,000 15,000
10,000 10,000
150,000 167,000
250,000 283,000
91,667 90,000
24,000 24,000
115,667 114,000
134,333 169,000
67,167 84,500
67,167 84,500
91,667 90,000
158,833 174,500
1.89 1.72

Machine A Machine B
400,000
20,000
Discount
Present Value Cash Inflow Present Value Factor
36,400 120,000 109,200 0.910
 99,600 160,000 132,800 0.830
120,000 200,000 150,000 0.750
163,200 120,000 81,600 0.680
99,200 80,000 49,600 0.620
518,400 680,000 523,200
418,200 418,200
100,200 105,000

Project I Project II
50,000
Discount
Cum. Cash In Cash Inflow Cum. Cash In Factor
25,000 10,000 10,000
40,000 12,000 22,000
50,000 18,000 40,000
50,000 25,000 65,000
62,000 8,000 73,000
68,000 4,000 77,000
3 3.4

Project I Project II
50,000 Discount
Present Value Cash Inflow Present Value Factor
22,725 10,000 9,090 0.909
12,390 12,000 9,912 0.826
7,510 18,000 13,518 0.751
0 25,000 17,075 0.683
7,452 8,000 4,968 0.621
3,384 4,000 2,256 0.564
53,461 56,819
3,461 6,819