Question

The Short-Line Railroad is considering a $125,000 investment in either of two companies. The cash flows are as follows:

Year	Electric Co.			Water Works
1	$	90,000		$	15,000
2		20,000			20,000
3		15,000			90,000
4 – 10		15,000			15,000

a. Compute the payback period for both companies. (Round your answers to 1 decimal place.)

Electric Co.		Years
Water Works		Years

b. Which of the investments is superior from the information provided?

Answer 1

Payback Period for Electric Co.

Year	Cash inflow ($)	Cumulative net Cash flow ($)
0	-1,25,000	-1,25,000
1	90,000	-35,000
2	20,000	-15,000
3	15,000	0
4	15,000	15,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Years + ($15,000 / $15,000)

= 2.00 Years + 1.00 Year

= 3.00 Years

= 3.0 Years

Payback Period for Water Works

Year	Cash inflow ($)	Cumulative net Cash flow ($)
0	-1,25,000	-1,25,000
1	15,000	-1,10,000
2	20,000	-90,000
3	90,000	0
4	15,000	15,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Years + ($90,000 / $90,000)

= 2.00 Years + 1.00 Year

= 3.00 Years

= 3.0 Years

DECISION

The Both Investment Projects are acceptable, since it has the same payback period of 3.00 Years.