Question

Assume a \$45,000 investment and the following cash flows for two alternatives: Year Investment A Investment...

Assume a \$45,000 investment and the following cash flows for two alternatives:

 Year Investment A Investment B 1 \$10,000 \$10,000 2 15,000 15,000 3 15,000 30,000 4 15,000 — 5 3,900,000 —

Calculate the payback for investment A and B. (Round the final answers to 2 decimal places.)

 Payback period Investment A years Investment B years

Which of the alternatives would you select under the payback method?

• Investment A

• Investment B

A:

 Year Cash flows Cumulative Cash flows 0 (45000) (45000) 1 10,000 (35000) 2 15000 (20,000) 3 15000 (5000) 4 15000 10,000 5 3,900,000 3,910,000

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

=3+(5000/15000)

=3.33 years(Approx)

B:

 Year Cash flows Cumulative Cash flows 0 (45000) (45000) 1 10,000 (35000) 2 15000 (20,000) 3 30,000 10,000

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+(20,000/30,000)

=2.67 years(Approx)

Hence B must be selected having lower payback.

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