Question

XYZ Corporation is considering the manufacture of a thermosetting resin as packaging material. R&D Teams have developed two alternatives: Synthetic Resin, and Epoxy Resin. The following tables show the expected CFFA from each project. Synthetic Resin Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Net Cash Flow (1,100,000) 150,000 200,000 300,000 650,000 700,000 Epoxy Resin Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Net Cash Flow (850,000) 650,000 400,000 300,000 250,000 200,000 a. What is the best project according to the payback method?

Answer 1

The details of two alternatives are:-

Synthetic Resin Epoxy Resin

Year 0 (1100000) (850000)

Year 1 150000 650000

Year 2 200000 400000

Year 3 300000 300000

Year 4 650000 250000

Year 5 700000 200000

In case of Synthetic Resin:-

Net Cash Flow Cumulative cash flow

Year 0 (1100000) (1100000)   

Year 1 150000 (950000)

Year 2 200000 (750000)   

Year 3 300000 (450000)

Year 4 650000 200000

Year 5 700000 900000   

Payback period of Synthetic Resin=3+(450000/650000)

=3.69 years

In case of Epoxy Resin:-

Net Cash Flow Cumulative cash flow

Year 0 (850000) (850000)   

Year 1 650000 (250000)

Year 2 400000 250000   

Year 3 300000 550000

Year 4 250000 750000

Year 5 200000 950000

Payback period of Epoxy Resin=1+(200000/400000)

=1.5 years

So, as payback period of Synthetic Rasin is 3.69 years and in case of Epoxy Rasin it is 1.5years,as the payback period of Epoxy Rasin is less,this project is better.