Long-term investment decision, payback method Personal Finance Problem Bill Will

Question

Long-term investment decision, payback method Personal Finance Problem Bill Williams has the opportunity to invest in project A that costs $5,500 today and promises to pay annual cash flows of $2,200, $2,400, $2,400, $1,900 and $1,800 over the next 5 years. Or. BUI can invest $5,500 in project B that promises to pay annual cash flows of $1,400, $1,400, $1,400, $3,400 and $3,900 over the next 5 years. How long will it take for Bill to recoup his initial investment in project A? How long will it take for Bil to recoup his initial investment in project B? Using the payback period, which project should Bill choose? For Bill to recoup his initial investment in project A. it will take years. (Round to two decimal places.)

Explanation / Answer

Alternative A Alternative B Yr Cash Flow Cumulative cash flow Cash Flow Cumulative cash flow 0 -5500 -3300 -5500 -4100 1 2200 -1100 1400 -2700 2 2400 1300 1400 -1300 3 2400 3700 1400 100 4 1900 5600 3400 3500 5 1800 7400 3900 7400 Payback Period = A+ B/C In the above formula, A is the last period with a negative cumulative cash flow; B is the absolute value of cumulative cash flow at the end of the period A; C is the total cash flow during the period after A Alternative A Payback Period = 1+1100/2400 =                 1.46 YR Alternative B Payback Period = 2+1300/1400 =                 2.93 YR Decision Rule Accept the projectWITH LOWER PAYBACK PERIOD I.E PROJECT A

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