Question

Assume a $40,000 investment and the following cash flows for two alternatives. Year Investment A Investment B 1 $ 5,000 $ 25,000 2 12,000 10,000 3 15,000 20,000 4 10,000 — 5 10,000 — a. Calculate the payback for investment A and B. (Round your answers to 2 decimal places.) b. Which investment would you select under the payback method? Investment A Investment B c. If the inflow in the fifth year for Investment A was $10,000,000 instead of $10,000, would your answer change under the payback method? Yes No

Answer 1

* Payback period = year before investment realization + (Difference in amount / Cash flow in next years)

* A's - Payback period = 3 + (8000 / 10000) = 3.80 Years

* B's - Payback period = 2 + (5000 / 20000) = 2.25 Years

b. Which investment would you select under the payback method? Investment B (Since it has lowest Payback period)

c. If the inflow in the fifth year for Investment A was $10,000,000 instead of $10,000, would your answer change under the payback method? No (because payback period ignores cash flow which occurs after payback periods)