Question

Long-term investment? decision, payback method Personal Finance Problem???

Bill Williams has the opportunity to invest in project A that costs $7,400 today and promises to pay annual cash flows of $2,200?, 2,400?, $2,400?, $2,000 and $1,800 over the next 5 years. ? Or, Bill can invest $7,400 in project B that promises to pay annual cash flows of $1,400?, $1,400?, $1,400?, $3,500 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?

Answer 1

Project A
Year	Cash flows	Cumulative CF
0	-7400	-7400
1	2200	-5200
2	2400	-2800
3	2400	-400
4	2000	1600
5	1800	3400
Payback period of A: 3 years + 400/2000 = 3.2 years
Project B
Year	Cash flows	Cumulative CF
0	-7400	-7400
1	1400	-6000
2	1400	-4600
3	1400	-3200
4	3500	300
5	4100	4400
Payback period of B= 3 years + 3200 /3500 = 3.9 years
Project A shall be accepted
Yes, the Management has selected the project with the earliest payback period. However, the management has not taken in to consideration the profits realised by the project post pay back period, which is more in case of Project B.