Question

QUESTION ONE [25]
1.1 Consider two projects whose cash inflows are not even. Assume that the project costs
R200 000. The net cash inflow for each year is as foLLOWS:

YEAR	PROJECT B	PROJECT C
1	20 000	100 000
2	40 000	80 000
3	60 000	60 000
4	80 000	20 000
5	100 000	-
6	100 200	-

required:
1.1.1 Calculate the payback period of each project and recommend the project that should be
selected based on the payback period.

Answer 1

B:

Year	Cash flows	Cumulative Cash flows
0	(200,000)	(200,000)
1	20,000	(180,000)
2	40,000	(140,000)
3	60,000	(80,000)
4	80,000	0
5	100,000	100,000
6	100200	200200

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=4 years

C:

Year	Cash flows	Cumulative Cash flows
0	(200,000)	(200,000)
1	100,000	(100,000)
2	80,000	(20000)
3	60000	40000
4	20000	60000

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=2+(20000/60000)

=2.33 years(Approx).

Hence C must be selected having lower payback.