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 $7,500 today and promises to pay annual cash flows of $2,200, $2,400, $2,400, $1,900 and $1,900 over the next 5 years. Or, Bill can invest $7,500 in project B that promises to pay annual cash flows of $1,500, $1,500, $1,500, $3,400 and $4,100 over the next 5 years. (Hint: For mixed stream cash inflows, calculate cumulative cash inflows on a year-to-year basis until the initial investment is recovered.) 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

a. amount earned in 3 years = 2200 + 2400 + 2400 = 7000

time taken to recoup in Project A = 3 + 500/1900 = 3.26 years

b. amount collected in 3 years = 1500 + 1500 + 1500 = 4500

time taken to recoup in Project B = 3 + 3000/3400 = 2.88 years

c. Bill should choose A based on payback

d. the payback fails to consider the cash flows beyond the payback period

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