Long-term investment decision, payback method Bill Williams has the opportunity

Question

Long-term investment decision, payback method Bill Williams has the opportunity
to invest in project A that costs $9,000 today and promises to pay annual end-ofyear
payments of $2,200, $2,500, $2,500, $2,000, and $1,800 over the next 5 years.
Or, Bill can invest $9,000 in project B that promises to pay annual end-of-year payments
of $1,500, $1,500, $1,500, $3,500, and $4,000 over the next 5 years.
a. How long will it take for Bill to recoup his initial investment in project A?
b. How long will it take for Bill to recoup his initial investment in project B?
c. Using the payback period, which project should Bill choose?
d. Do you see any problems with his choice?

Explanation / Answer

a)

Payback Period = 3+ (1800/2000)

= 3+ 0.9

=3.9 years

b)

Payback Period = 4+ (1000/4000)

= 4+.25

=4.25 years

c) Project A should be chosen because it will take less years to recoup initial investment than Project B.

d) No

year Cash Flow Cumulative Cash Flow 0             (9,000)                                    (9,000) 1               2,200                                    (6,800) 2               2,500                                    (4,300) 3               2,500                                    (1,800) 4               2,000                                          200 5               1,800                                      2,000

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