Bailey Airline Company is considering expanding its territory. The company has t

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 $22,620,000, it will enable the company to increase its annual cash inflow by $5,800,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $40,920,000; it will enable the company to increase annual cash flow by $9,300,000 per year. This plane has an eight-year useful life and a zero salvage value. Required a-1. Determine the payback period for each investment alternative. (Round your answers to 1 decimal place.) Alternative 1 Alternative 2 Payback Period years years a-2. Identify the alternative Bailey should accept if the decision is based on the payback approadh. O Alternative 1 Alternative 2

Explanation / Answer

Solution:

Payback Period

Payback period is the length of time within which initial investment is recovered back to the company.

It is a technique of evaluating investment. It does not consider time value of money.

Payback Period in cash of uniform cash flow = Initial Investment / Uniform Annual Cash Flow

a-1)

Payback Period for Alternative 1 = Initial Investment $22,620,000 / Uniform Annual Cash Flow $5,800,000 = 3.9 Years

Payback Period for Alternative 2 = Initial Investment $40,920,000 / Uniform Annual Cash Flow $9,300,000 = 4.4 Years

a-2)

Selection Criteria under payback period is the project or alternative having less payback period should be selected or preferred first.

Hence, Alternative 1 has shortest payback period. Alternative 1 should be accepted.

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