Question

Stenson, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available. Year Cash Flow A Cash Flow B 0 -$52,000 -$ 97,000 20,500 22,500 27,200 27,500 22,500 31,500 8,500 243,000 NM What is the payback period for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) years Project A Project B years Which, if either, project(s) should the company accept?

Answer 1

Payback Period =	A +	B
		C

Where,
A is the last period number with a negative cumulative cash flow;
B is the absolute value (i.e. value without negative sign) of cumulative net cash flow at the end of the period A; and
C is the total cash inflow during the period following period A

The following table shows the calculations :

Cash Flow A

Year	Cash Flow	Cumulative Cash Flow
0	-52000	-52000
1	20500	-31500
2	27200	-4300
3	22500	18200
4	8500	26700

So, Payback period

= 2 + | - 4,300 | / 22,500

= 2 + 0.19

= 2.19 Years

Cash Flow B

Year	Cash Flow	Cumulative Cash Flow
0	-97000	-97000
1	22500	-74500
2	27500	-47000
3	31500	-15500
4	243000	227500

So, Payback period

=3 + | - 15,500 | / 243,000

= 3 + 0.06

= 3.06 Years

The lesser the payback period, the more quicker the investment will get recovered. So, the project with lesser payback period should be accepted, that is, Project A should be selected