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Answer :
The Growth Proposal, it would take RMC approximately: 5.8 years to pay back the investment on new equipment for Option 1 of the growth proposal.
To calculate the payback period, we need to determine the year in which the accumulated cash inflows equal the initial investment.
First, we need to calculate the annual cash inflows, which are the expected annual revenue multiplied by the profit margin after tax for each year.
For Option 1:
Annual cash inflows for Year 1 = $300,000 x 15% = $45,000
Annual cash inflows for Year 2 = $300,000 x 20% = $60,000
Annual cash inflows for Years 3-10 = $300,000 x 30% = $90,000
Next, we need to calculate the cumulative cash inflows for each year.
Cumulative cash inflows for Year 1 = $45,000
Cumulative cash inflows for Year 2 = $105,000 ($45,000 + $60,000)
Cumulative cash inflows for Year 3 = $195,000 ($105,000 + $90,000)
Cumulative cash inflows for Year 4 = $285,000 ($195,000 + $90,000)
Cumulative cash inflows for Year 5 = $375,000 ($285,000 + $90,000)
Cumulative cash inflows for Year 6 = $465,000 ($375,000 + $90,000)
Therefore, it would take RMC approximately 5.8 years to pay back the investment on new equipment, since that is the year when the cumulative cash inflows exceed the initial investment of $500,000.
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Complete question:
New Growth Proposal After researching the market, RMC has determined that adding a new product would help stimulate growth and profitability. They are considering two options:
1) Manufacture the part themselves by buying new equipment
2) Outsource the part through a third-party vendor
Option 1: Manufacture with New Equipment Cost of New Equipment $500,000 8 Years, Loan Terms 5% Fixed Interest Expected Annual Revenue $300,000 Profit Margin After Tax (Including Interest): Year 1, Year 2, Years 3-10 15%, 20%, 30%
Option 2: Outsource Expected Annual Revenue $300,000 Annual Profit Margin After Tax 10% Return
For Option 1 of the Growth Proposal, how long would it take RMC to pay back the investment on new equipment?
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