Engineering Economic Analysis

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Payback Period 283

capital means that it can be reused sooner for other purposes. But one must not confuse the

,speedof the returnof the investment,as measuredby the paybackperiod,witheconomic

efficiency.They are two distinctly separate concepts. The former emphasizes the quickness

with which invested funds return to a firm; the latter considers the overall profitability of

the investment.

We can create another situation to illustrate how selecting between alternativesby the

payback period criterion may result in an unwise decision.

A :firmis purchasing production equipment for a new plant. Two alternative machines are being

considered for a particular operation..

Installed cost

Net annual benefit after

all annual expenses

have been deducted

Useful life, in years

Tempo Machine

$30,000

$12,000 the first year,

declining $3000 per year

thereafter

4

Dura Machine

$35,000

$1000 the first year,

increasing $3000

per year thereafter

8

Neither machine has any salvage value. Compute the payback period for each of the alternatives.

SOLUTION BASED ON PAYBACKPERIOD

Cost= $35,000

1 2 3 4 5

Year

(a) (b)

FIGURE 9-4 Payback period plots for Example 9-7: (a) Tempo machine and (b) Dura machine.

=The Tempo machine has a declining annual benefit, while the Dura has an increasing annual

benefit. Figure 9-4 shows the Tempo has a 4-year payback period and the Dura has a 5-year.

II ~ == Ril~b<!p!5;p~lii>4.lJ> .Q1ir}jmize.thepayback period, theTempo is selected.' ~ ~ ==1

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II

I'

:ill

II

$35,000 $35,000

Cost = $30,000

$30,000 ./T $30,000

.eo

$25,000I- !/ I $25,000

.<q'lJ

$20,000I- S'lJY I $20,000

$15,000I- 0 PI I $15,000

.... $10,000 $10,000

$5,000 $5,000

0 1 2 3 4 5 0

Year