Question

You are an investor who wants to make your investment back as quickly as possible. There are four potential projects that you can invest in. Which project should you choose?

	Project 1	Project 2	Project 3	Project 4
Initial Cost	$50,000	$60,000	$65,000	$125,000
Annual Revenues	8500	12,500	8,500	18,000
Length of Ownership	6	4	9	10

Answer 1

Project 1

Calculate Payback Period -

Year	Cash Inflow	Cumulative Cash Inflow
1	8500	8500
2	8500	17000
3	8500	25500
4	8500	34000
5	8500	42500
6	8500	51000

The initial investment is 50,000. Now, 42,500 is recovered in Year 5 and 7500 remains unrecovered.

So,

Payback period = 5 + (7500/8500) = 5 + 0.88 = 5.88 years

The payback period of Project 1 is 5.88 years.

Project 2

Calculate the payback period -

Year	Cash Inflow	Cumulative cash inflow
1	12500	12500
2	12500	25000
3	12500	37500
4	12500	50000

The initial investment in the Project 2 is 60000. Over the entire lifetime of project, initial cost cannot be recovered.

Project 3

Calculate the Payback Period -

Year	Cash Inflow	Cumulative cash inflow
1	8500	8500
2	8500	17000
3	8500	25500
4	8500	34000
5	8500	42500
6	8500	51000
7	8500	59500
8	8500	68000
9	8500	76500

The initial investment is 65,000. Now, 59,500 is recovered in Year 7 and 5500 remains unrecovered.

So,

Payback period = 7 + (5500/8500) = 7 + 0.65 = 7.65 years

The payback period of Project 3 is 7.65 years.

Project 4

Calculate the Payback Period -

Year	Cash Inflow	Cumulative Cash Inflow
1	18000	18000
2	18000	36000
3	18000	54000
4	18000	72000
5	18000	90000
6	18000	108000
7	18000	126000
8	18000	144000
9	18000	162000
10	18000	180000

The initial investment is 125,000. Now, 108000 is recovered in Year 6 and 17000 remains unrecovered.

So,

Payback period = 6 + (17000/18000) = 6 + 0.94 = 6.94 years

The payback period of Project 4 is 6.94 years.

Investor wants to make his investment back as quickly as possible.

This means he wants to invest in that projectc which has the smallest payback period.

Project 1 has the smallest payback period.

So, Project 1 should be selected.