Choosing between two projects with acceptable payback periods Shell Camping Gear

Question

Choosing between two projects with acceptable payback periods Shell Camping Gear, Inc., is considering two mutually exclusive projects. Each requires an initial investment of $100,000. John Shell, president of the company, has set a maximum payback period of 4 years. The after-tax cash inflows associated with eac project are shown in the following table: EEB a. Determine the payback period of each project. b. Because they are mutually exclusive, Shell must choose one. Which should the company invest in? a. The payback period of project A is yers. (Round to two decimal places.) Data Table (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Cash inflows (CF) Project A 10,000 $20,000 $30,000 $40,000 $20,000 Year Project B $40,000 30,000 $20,000 10,000 $20,000 4 PrintDone

Explanation / Answer

Solution:-

Concept:- Payback period is that period during which the investment amount is recovered.

a) Calculation of payback period

Years

Cash flow of Project A

Cumulative Cash flow of Project A

Cash flow of Project B

Cumulative Cash flow of Project B

1

$10,000

$10,000

$40,000

$40,000

2

$20,000

$30,000

$30,000

$70,000

3

$30,000

$60,000

$20,000

$90,000

4

$40,000

$100,000

$10,000

$100,000

5

$20,000

$120,000

$20,000

$120,000

Initial investment amount= $100,000

a) i)Payback period of Project-A= 4 years

      Since the $100,000 was recovered in 4 years exactly. Hence the pay back period =4 years

ii)Payback period of Project-B= 4 years

      Since the $100,000 was recovered in 4 years exactly. Hence the payback period of project-B=4 years

b)We should invest in Project -B

Explanations:-

   The pay back period of both project is same. However in Project-B there is higher recovery in the earlier years than Project-A , which will lead to higher NPV hence higher benefit.

Please feel free to ask if you have any query in the comment section.

Years

Cash flow of Project A

Cumulative Cash flow of Project A

Cash flow of Project B

Cumulative Cash flow of Project B

1

$10,000

$10,000

$40,000

$40,000

2

$20,000

$30,000

$30,000

$70,000

3

$30,000

$60,000

$20,000

$90,000

4

$40,000

$100,000

$10,000

$100,000

5

$20,000

$120,000

$20,000

$120,000

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