Question

Assume a $70,000 investment and the following cash flows for two alternatives.

Year	Investment X			Investment Y
1		$15,000			$35,000
2		20,000			20,000
3		20,000			20,000
4		20,000			—
5		15,000			—

a. Calculate the payback for investment X and Y. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
  

b. Which alternative would you select under the payback method?
  

	Investment X
	Investment Y

Answer 1

Investment X

Year	0	1	2	3	4	5
Cashflow(in $)	(70,000)	15,000	20,000	20,000	20,000	15,000
Cumulative Cashflow(in $)	(70,000)	(55,000)	(35,000)	(15,000)	5,000	20,000

Payback Period = A+(B/C)

where

A - last period containing negative cumulative cash flow = 3

B - absolute value of cumulative cash flow in A = 15000

C - cash flow during the period after A = 20000

Payback Period = 3+(15000/20000)

= 3.75 years

Investment Y

Year	0	1	2	3
Cashflow(in $)	(70,000)	35,000	20,000	20,000
Cumulative Cashflow(in $)	(70,000)	(35,000)	(15,000)	5,000

Payback Period = A+(B/C)

where

A - last period containing negative cumulative cash flow = 2

B - absolute value of cumulative cash flow in A = 15000

C - cash flow during the period after A = 20000

Payback Period = 2+(15000/20000)

= 2.75 years

Decision: Investment Y as it has lower Payback period, so it should be selected