Question

DEF, Inc. is considering the following two mutually exclusive projects with similar risks

Year	Project A	Project B
0	– $60,000	– $60,000
1	20,500	18,200
2	15,600	24,400
3	24,400	15,600
4	18,200	20,500

(c) Calculate the payback periods. The target payback period is 2 years. Which project will you choose if you apply the payback period rule?

Answer 1

Payback period of both the project should be as follows-

Project A is having a initial outflow of 60000.

It is having inflows of cash in first 2 years

=[20500+15600]= 36100

In third year it is receiving, 24400

Payback period= 2+((60,000-36100)/24400)

= 2+.9795

= 2.9795 years.

Payback period of Project B-

Total outflow of the project is 60000.

Cash flows in first 3 years=[18200 + 24400+15600]= 58,200

Payback period= 3+[(60000-58200)/20500]

=3+.087

= 3.087 years.

It is given that the target payback period is 2 years so at least the project would have been provided with the the amount of outflow in 2 years but none of the project had provided the outflow in 2 year so none of the project will be accepted by the company.

None of the projects should be accepted.