Question

A domestic producer of baby carriages, Pramble, buys the wheels from a company in the north of England. Currently the wheels cost $4 each, but for a number of reasons the price will double. In order to produce the wheels themselves, Pramble would have to add to existing facilities at a cost of $800,000. It estimates that its unit cost of production would be $3.50. At the current time, the company sells 10,000 carriages annually. (Assume there are four wheels per carriage.)

a. At the current sales rate, how long would it take to pay back the investment for the required expansion?

b. If sales are expected to increase at a rate of 15% per year, how long will it take to pay back the expansion?

Answer 1

Answer:

(a) The formula to calculate Payback is as under:

Payback Period = Investment / (Net Cash Inflows)

The net contribution per unit =  $8 - $3.5 = $4.5 per unit

Net Cash inflows = $4.5 * 10,000 = $45,000

Payback Period = $800,000 / $45,000 = 17.76 years

(b) If the sales are expected to increase by 15% then the total sales calculated would increase by 15%

Total Sales = $45,000 * 115% = $51750

Payback Period = $800,000 / $51,750 = 15.46 years