5. The B & O Railroad is considering a $100,000 investment in either of two comp

Question

5. The B & O Railroad is considering a $100,000 investment in either of two companies. The cash flows are as follows:

Year                Electric Company                  Water Works

1                         $70,000                                $15,000

2                          15,000                                   15,000

3                          15,000                                   70,000

4-10                      10,000                                  10,000

a. Using the payback method, what will the decision be?

b. Explain why the answer in part a can be misleading.

Explanation / Answer

(a) Payback ofElectric Company = 3years

Payback ofWater Works= 3 years

Using the payback method, the company and choose any. since their payback is the same it doesnot matter which one is choosen.

(b)the answer in part a can be misleading, because the present value of the cashflow is not considered.

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