Long-term investment decision, payback method Personal Finance Problem Bill Will
ID: 2766913 • Letter: L
Question
Long-term investment decision, payback method Personal Finance Problem Bill Williams has the opportunity to invest in project A that costs $8,300 today and promises to pay annual cash flows of $2,200, $2,400, $2,400, $2,100 and $1,900 over the next 5 years. Or, Bill can invest $8,300 in project B that promises to pay annual cash flows of $1,500, $1,500, $1,500, $3,700 and $4,000 over the next 5 years.
a. How long will it take for Bill to recoup his initial investment in project A? b. How long will it take for Bill to recoup his initial investment in project B? c. Using the payback period, which project should Bill choose? d. Do you see any problems with his choice?
a. For Bill to recoup his initial investment in project A, it will take
years. (Round to two decimal places.)
Explanation / Answer
Project A
Year
CashFlow
Cum Cash Flow
-
(8,300)
(8,300)
1
2,200
(6,100)
2
2,400
(3,700)
3
2,400
(1,300)
4
2,100
800
5
1,900
2,700
Payback Period= 3+1,300/2,100=3+0.62=3.62 years
Project B
Year
CashFlow
Cum Cash Flow
0
(8,300)
(8,300)
1
1,500
(6,800)
2
1,500
(5,300)
3
1,500
(3,800)
4
3,700
(100)
5
4,000
3,900
Payback Period= 4+100/3,900
=4+0.03=4.03 years
We should choose Project A as payback period is less.
Project B initial returns is less hence payback period increased
Project A
Year
CashFlow
Cum Cash Flow
-
(8,300)
(8,300)
1
2,200
(6,100)
2
2,400
(3,700)
3
2,400
(1,300)
4
2,100
800
5
1,900
2,700
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