Question

21) (4 pts) Two proposed investments (A and B) have the following cash flows. On the basis of Payback Period, which investment would you choose? Explain any concerns you should have with relying on the payback period. Ү А в -10 0 1 2 3 -10 4 4 4 4 20 ΤΑ Payback Period CHOICE? (Check a box)

Answer 1

Payback Period for PROJECT-A

Year	Annual cash flows ($)	Cumulative Annual cash flows ($)
0	-10.00	-10.00
1	4.00	-6.00
2	4.00	-2.00
3	4.00	2.00
4	4.00	6.00

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

= 2.00 Years + ($2.00 / $4.00)

= 2.00 Years + 0.50 Years

= 2.50 Years

Payback Period for PROJECT-B

Year	Annual cash flows ($)	Cumulative Annual cash flows ($)
0	-10.00	-10.00
1	2.00	-8.00
2	2.00	-6.00
3	2.00	-4.00
4	20.00	16.00

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

= 3.00 Years + ($4.00 / $20.00)

= 3.00 Years + 0.20 Years

= 3.20 Years

DECISION

The PROJECT-A should be accepted, since the Project-A has the lower payback period of 2.50 Years as compared to the payback period of Project-B.