Question

# TABLE 3 Project A Project B Time 0 -11,000 -10,000 Time 1 3,000 4,000 Time 2...

 TABLE 3 Project A Project B Time 0 -11,000 -10,000 Time 1 3,000 4,000 Time 2 8,000 3,000 Time 3 3,000 10,000

"Consider the cash flow of the two projects depicted in Table 3. If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will rank highest?"

 A) Project A B) Project B C) Project A and Project B have the same ranking. D) Cannot calculate a payback period without a discount rate.

A:

 Year Cash flows Cumulative Cash flows 0 (11000) (11000) 1 3000 (8000) 2 8000 0 3 3000 3000

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 years

B:

 Year Cash flows Cumulative Cash flows 0 (10,000) (10,000) 1 4000 (6000) 2 3000 (3000) 3 10,000 7000

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+(3000/10,000)

=2.3 years

Hence Project A would rank highest having lower payback period.

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