solve this giving necessary steps........... A company is considering two projec
ID: 2671257 • Letter: S
Question
solve this giving necessary steps...........A company is considering two projects. A project A requires a $100,000 investment and is expected to generate the following cash flows in the years after the investment is made:
Year Cash Flow
1 $60,000
2 40,000
3 10,000
4 10,000
Project B requires a $100,000 investment and is expected to generate the following cash flows in the years after the investment is made:
Year Cash Flow
1 $50,000
2 40,000
3 40,000
4 80,000
What project has the shortest payback period? Discuss the weakness in choosing this projects.
Explanation / Answer
: Project A has a payback period of 2.0 years, as its cumulative cash inflows are $100,000 by the end of the second year. Projects B’s payback period is 2.25 years, as its cumulative cash flows reach $100,000 at the end of the third year’s first quarter. Thus, Project A has a shorter payback period. This outcome illustrate s the weakness of the payback period method. Project B has significant cash flows after the payback period is reached. In comparison, Project A’s cash flows drop dramatically. If a 10% discount rate is used, the NPV for A is $1,947 and the NPV for B is $63,206. Clearly B is the superior project.
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