Question

Assume a $250,000 investment and the following cash flows for two alternatives:

Year Product X    Product Y

1 $ 90,000   $ 50,000

2 90,000 80,000

3 60,000 60,000

4 20,000   70,000

a. Calculate the payback for products X and Y. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Payback

Product X years

Product Y years

b. Which of the alternatives would you select under the payback method?

Product X

Product Y

Answer 1

a.

Payback Period
Product X	3.5 Years
Product Y	3.86 Years

b.

Under payback method, Product X should be selected as it has lower payback period than Product Y.

Explanation:

Payback period = A + B/C

A = Last period number with a negative cumulative cash flow

B = Absolute value of cumulative cash flow at the end of period A

C = Total cash flow during the period following period A.

	Product X	Product Y
Year	Cash Flow	‘Cum Cash Flow	Cash Flow	‘Cum Cash Flow
0	-$250,000	-$250,000	-$250,000	-$250,000
1	90,000	-160,000	50,000	-200,000
2	90,000	-70,000	80,000	-120,000
3	60,000	-10,000	60,000	-60,000
4	20,000	10,000	70,000	10,000

Payback period for Product X = 3 + $ 10,000/$ 20,000

                                                 = 3 + 0.5 = 3.5 years

Payback period for Product Y = 3 + $ 60,000/$ 70,000

                                                = 3 + 0.857142857 = 3.86 years