ongterm investment decision, payback method Personal Finance Pr í m Ba Wiliams h

Question

ongterm investment decision, payback method Personal Finance Pr í m Ba Wiliams has th·opportunty to i vest n pre ect A that costs s sooday and promises to pay annual cash f ws of 2,500, $2500, $2,100 and $1,700 over the next 5 years. Or, Bl can invest $8,500 in project B that promises to pay annual cash fows of $1,500, $1,500, $1,500, $3,700 and $4,100 over the next 5 years. (Hint For xed stream cath inlows, cakulale cumulative cash infows on a year to-year basit unil the initial investmend is ecovered How long will it take for Bill to reooup his initial investment in project A? . How long wil t take for Bil to recoup his initial investment in peojnot 8 Uing he payback peniod, which proet hould Bil choose? . Do you seo any probiems with his choice? . For Bil to recoup his intial mosnent in proioctA,itwiltake. ?yors (Reurd to two decinal places.)

Explanation / Answer

Basic calculations before answering the parts of question

Question - A Payback period for Project - A = 3 years + 1400 / 2100 =  3.67 Years

Questionn - B Pay back period for Project - B = 4 Years + 300 / 4100 = 4.07 Years

Question - C Using the payback period method, we have to select project with lowest payback period. Hence Project - A should be choosen

Question - D ...... Yes, the post payback profitability is not taken into consideration. After payback in 3.67 years, project - A had post payback profitability of 2400 only but Project - B had 3800. Thus payback period method can lead to wrong decisions.

           PROJECT - A      PROJECT - B Year CF Cumulative CF Year CF Cumulative CF 0 -8500 -8500 0 -8500 -8500 1 2100 -6400 1 1500 -7000 2 2500 -3900 2 1500 -5500 3 2500 -1400 3 1500 -4000 4 2100 700 4 3700 -300 5 1700 2400 5 4100 3800

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