Background: The tables below are summaries of three projects (A, B, and C). Thes
ID: 1109118 • Letter: B
Question
Background: The tables below are summaries of three projects (A, B, and C). These are investments into capital assets, more specifically, commercial real estate. These types of investments will yield the investor a cash flow, and when the investor so chooses, a face value at maturity. Maturity can be forced only at the end of a year (i.e. the sale, and hence, forced maturity of this investment can be done at the end of year 1, OR the end of year 2, QR the end of year 3, etc.) Project A Cash Flow Face Value Initial Investment is $500,000 Year 1 Year 4 Year 5 Year 2 S 95,000 S 175,000 1,600,000 2,900,000 Year 3 S 220,000 S 3,600,000 $225,000 $3,660,000 S 215,000 3,500,000 Required Rate of Return is 15% Year 5 Project B Cash Flow Face Value Initial Investment is $700,000 Year 3 Year 4 S 440,000 S 7,300,000 Year 1 Year 2 S 310,000 380,000 $ 415,000 s 5200,000 6,400,000 6,900.000 7.300,000$7.800,000 $ 6,900,000 $7,800,000 Required Rate of Return is 15% Project C Cash Flow Face Value Initial Investment is $2,080,000 Year 1 Year 2 S 380,000 401,000 S 8,300,000 S 8,500,000 Year 3 Year 4 Year 5 425,000 S 430,000 $445,000 $8,700,000 S 8,900,000 Required Rate of Return is 15% Use the above tables to calculate the payback periods of each project. Rank these projects from quickest payback period to the longest payback period. (Round to the nearest month, for example if the answer is 3 years 2 months and 1 week, then an answer of 3 years and 2 months will suffice) 1.Explanation / Answer
Payback period is period which indicates investor that in how many years, months and weeks they will get their investment back which they have put in project.
Payback Period of Project A
Cash Flow of Project A for each year is below
Year 1 – $95,000, Year 2 – $175,000, Year 3 – $215,000, Year 4 - $220,000,
Year 5 - $225,000
Initial Investment is of $500,000
If we add up cash flows for 3 years, its total is $485,000 and remaining $15,000 we take from $220,000 of year 4.
$(95,000+175,000+215,000) in first 3 years = $485,000
=> $485,000 + $15,000 of $220,000 occurring in Year 4
Taking $15,000 from Year 4 cashflow $220,000
=> 15000/225000 = 0.068 weeks
=> 3 years and 0.068 weeks
Hence, Payback period of Project A in which investor gets their investment back is 3.068 years i.e. 3 years (rounding off)
Payback Period of Project B
Cash Flow of Project B for each year is below
Year 1 – $310,000, Year 2 – $380,000, Year 3 – $415,000, Year 4 - $440,000,
Year 5 - $470,000
Initial Investment is of $700,000
If we add up cash flows for 2 years, its total is $690,000 and remaining $10,000 we take from $415,000 of year 3.
$(310,000+380,000) in first 2 years = $690,000
=> $690,000 + $10,000 of $45,000 occurring in Year 3
Taking $10,000 from Year 3 cashflow $415,000
=> 10000/415000 = 0.024 weeks
=> 2 years and 0.024 weeks
Hence, Payback period of Project B in which investor gets their investment back is 2.024 years i.e. 2 years (rounding off)
Payback Period of Project C
Cash Flow of Project C for each year is below
Year 1 – $380,000, Year 2 – $401,000, Year 3 – $425,000, Year 4 - $430,000,
Year 5 - $445,000
Initial Investment is of $2,080,000
If we add up cash flows for 5 years, its total is $2,081,000 and surplus $1000 at the end of year 5.
$(380,000+401,000+425,000+430,000+445,000) in 5 years = $2,810,000
Hence, Payback period of Project C in which investor gets their investment back is 5 years.
Below is the Ranking of these projects from quickest payback period to longest payback period.
Rank 1 – Project B (2 years)
Rank 2 – Project A (3 years)
Rank 3 – Project C (5 years)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.