Question

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.

Answer 1

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.