Assume a $72,000 investment and the following cash flows for two alternatives. Y

Question

Assume a $72,000 investment and the following cash flows for two alternatives. Year Investment A Investment B 1 $ 25,000 $ 22,000 2 25,000 15,000 3 15,000 50,000 5 10,000 — 5 30,000 —

a. Calculate the payback for investment A and B. (Round your answers to 2 decimal places.) Payback Investment A years Investment B years

b. Which investment would you select under the payback method? Investment A Investment B

c. If the inflow in the fifth year for Investment A was $30,000,000 instead of $30,000, would your answer change under the payback method? Yes No

Explanation / Answer

Payback period of the investment refers to 'The time period required to recover the cost of the investment' It helps in decision making of an investment.Payback method doesn't consider time value of money.

The pay back period is expressed in years. The lesser payback period investment is preferable than the higher payback period investment.The payback period determines how fast a project will recover its Cash investment, it does not determine the profitability of an investment.

Formula for calculation of Payback period :

Payback period = Initial Investment

Cash inflows during the period

In the given quetion cashflows are uneven therefore payback is calculated based on cumulative cashflows

A)   Investment A:

year cashflow   Cumulative cashflows

1 25000 25000

2 25000 50000

3 15000 65000

4 10000 75000

5 30000 105000   

The Payback period of the Investment A is 4 Years because in the year 4 the total Intial Investment will be recovered.

Investment B :

year   Cashflows    Cumulative cashflows

1 22000 22000

2 15000 37000

3 50000 87000

4 - 87000

5 - 87000

The Payback of Investment B is 3 Years because the total Intial investment of $72000 will recover In the year 3 itself.

B) As per Payback method lesser payback investment is more preferable than higher payback investment. Therefore Investment B is preferable than Investment A

C) No, the total intial investment of $72000 is will be recovered inyear 4 itself so changing of year 5 cash flows will not show any impact on payback. hence payback is 4 years only.

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