Which project has the better payback period? Project A requires a $25,000 investment and provides $5,000...

Which project has the better payback period? Project A requires a $25,000 investment and provides $5,000 per year for 6 years; Project B requires an $8,000 project and provides $4,000 per year for 2 years. Explain the strengths and weaknesses of this approach.

Expert Solution

Payback Period = Intial Investment / Cash Inflows.

The Project with early payback Period should be selected

For Project A = $25,000 / $5,000 = 5 years
For Project B = $8,000 / $4,000 = 2 years

Comment : Since Project B 'sPayback Period is less than Project A. Thus Project B have better payback period

Strengths of pay back period

A shorter payback period implies improvement of the liquidity position of a bussiness
Whenever there is cash crunch in the bussiness & fund availabe for investment is less than the payback period helps to choose a best project whose cost can be recover in short time.
It is very easy to calculate.

Weaknesses of pay back period

It does not consider the time value of money .
It does not consider the cash flows after the payback period.
It does not take into account the impact other moneytory risk that involves in the business

ekkarill92 answered 2 years ago

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