Question

In: Finance

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

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

Solutions

Expert Solution

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


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