Question

I. VDSL Company has two mutually exclusive projects. Below is a table representing the initial investment and cash flows for these projects over four (4) years.

Project A Project B Year Cash Flow Cash Flow $ $ 0 -750,000 -750,000 1 250,000 200,000 2 350,000 400,000 3 250,000 100,000 4 200,000 175,000 If the company wishes to recover the investment in 2.5 years, calculate the payback period of each project and determine which project is the best investment.

Answer 1

Payback Period for the PROJECT-A

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	-7,50,000	-7,50,000
1	2,50,000	-5,00,000
2	3,50,000	-1,50,000
3	2,50,000	1,00,000
4	2,00,000	3,00,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Year + ($150,000 / $250,000)

= 2.00 Year + 0.60 Years

= 2.60 Years

Payback Period for the PROJECT-B

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	-7,50,000	-7,50,000
1	2,00,000	-5,50,000
2	4,00,000	-1,50,000
3	1,00,000	-50,000
4	1,75,000	1,25,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 3.00 Year + ($50,000 / $175,000)

= 3.00 Year + 0.29 Years

= 3.29 Years

DECISION

The Project-A Should be accepted, since it has the lower payback period of 2.60 Years.