Question

A company is considering two short-term projects. Based on the payback period, which project is preferred?

Month	A	B
0	-$90	-$100
1	$30	$0
2	$20	$50
3	$20	$40
4	$20	$30
5	$20	$20
6	$10	$10

Answer 1

Following table shows the cumulative cash inflows of the Project A and Project B -

Month	Project A	Cumulative cash inflow of Project A	Project B	Cumulative cash inflow of Project B
1	$30	$30	$0	$0
2	$20	$50	$50	$50
3	$20	$70	$40	$90
4	$20	$90	$30	$120
5	$20	$110	$20	$140
6	$10	$120	$10	$150

The initial investment in Project A is $90.

Now, $90 is recovered in 4th month.

So,

Payback period for Project A is 4 months.

The initial investment in Project B is $100.

Now $90 is recovered in 3rd month and $10 remains unrecovered.

Payback period = 3 + ($10/$30) = 3 + 0.33 = 3.33 months

So,

Payback period for Project B is 3.33 months.

Project with shorter payback period should be selected.

Thus,

Project B is preferred.