Bailey Airline Company is considering expanding its territory. The company has t
ID: 2566291 • Letter: B
Question
Bailey Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $17,550,000; it will enable the company to increase its annual cash inflow by $6,500,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $31,960,000; it will enable the company to increase annual cash flow by $9,400,000 per year. This plane has an eight-year useful life and a zero salvage value.
Determine the payback period for each investment alternative. (Round your answers to 1 decimal place.)
Payback Years
Alternative 1: ___________ Years
Alternative 2: ___________ Years
Bailey Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $17,550,000; it will enable the company to increase its annual cash inflow by $6,500,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $31,960,000; it will enable the company to increase annual cash flow by $9,400,000 per year. This plane has an eight-year useful life and a zero salvage value.
Explanation / Answer
Solution:
a-1) Payback Period
Payback period is the length of time within which initial investment in the project is recovered back to the company.
IN case of Uniform Cash Inflow, payback period is calculated as follows:
Payback Period = Initial Investment / Uniform Annual Cash Inflow
Alternative 1 – First Plane
Payback Period = Initial Investment $17,550,000 / Uniform Annual Cash Inflow $6,500,000
= 2.7 years
Alternative 2 – Second Plane
Payback Period = Initial Investment $31,960,000 / Uniform Annual Cash Inflow $9,400,000
= 3.4 years
a-2)According to payback approach, the project having lower payback period should be selected.
The payback period under alternative 1 (First plane) is lower than Alternative 2.
Hence Alternative 1 should be selected.
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