You are considering two investment options. In option A, you have to invest S4,0

Question

You are considering two investment options. In option A, you have to invest S4,000 now and $1,000 three years from now. In option B, you have to invest S3,800 now, $1,900 a year from now, and $900 three years from now. In both options, you will receive four annual payments of $1,700 each. (You will get the first payment a year from now.) Which of these options would you choose based on (a) the conventional payback criterion, and (b) the present worth criterion, assuming 11% interest? Assume that all cash flows occur at the end of a year Click the icon to view the interest factors for discrete compounding when 11% per year. (a) The conventional payback period for option A isyears. (Round to the nearest whole number place.)

Explanation / Answer

(a) Payback period (Option A) is the time by when cumulative cash flow equals zero.

PBP for Option A lies between years 2 and 3. Cumulative cash flow is +$100 in year 3, which is the payback period.

Conventional payback period = 3 years

Year Cash Flow ($) Cumulative Cash Flow ($) 0 -4,000 -4,000 1 1,700 -2,300 2 1,700 -600 3 700 100 4 1,700 1,800

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