Question

Choosing between two projects with acceptable payback periods Shol Camping Gear, Inc., is considering two mutually exclusive projects. Each requires an initial investment of $180,000. John Shell, president of the company has set a maximum payback period of 4 years. The after tax cash inflows associated with each project are shown in the following table ! a. Determine the payback period of each project b. Because they are mutually exclusive Shell must choose one which should the company invest in?

Answer 1

3 Shell Campin Gear Project A Cash flows Cumulative cash flows Payback period 30000 - 180000 -180000 40000 -110000 50000 -60000 60000 0 20000 20000 - 150000 Project B Cash flows Cumulative cash flows Payback period -180000 -180000 60000 -120000 50000 -70000 40000 30000 30000 0 20000 20000

Both have equal payback period of 4 years.

However, as the projects are mutually exclusive, only one project must be chosen. From the above , Project B has higher cash flows coming in the beginning as compared to project A, and as the time period increases the probability of cash flow also decreases. So it is better for Shell Co to consider Project B over Project A. Moreover, Project B would end with with better discounted payback than project A due to higher cash flows in the beginning.