In: Finance
The Short-Line Railroad is considering a $125,000 investment in either of two companies. The cash flows are as follows:
Year | Electric Co. | Water Works | ||||
1 | $ | 90,000 | $ | 15,000 | ||
2 | 20,000 | 20,000 | ||||
3 | 15,000 | 90,000 | ||||
4 – 10 | 15,000 | 15,000 |
a. Compute the payback period for both companies. (Round your answers to 1 decimal place.)
Electric Co. | Years | |
Water Works | Years |
b. Which of the investments is superior from the information provided?
Payback Period for Electric Co.
Year |
Cash inflow ($) |
Cumulative net Cash flow ($) |
0 |
-1,25,000 |
-1,25,000 |
1 |
90,000 |
-35,000 |
2 |
20,000 |
-15,000 |
3 |
15,000 |
0 |
4 |
15,000 |
15,000 |
Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)
= 2.00 Years + ($15,000 / $15,000)
= 2.00 Years + 1.00 Year
= 3.00 Years
= 3.0 Years
Payback Period for Water Works
Year |
Cash inflow ($) |
Cumulative net Cash flow ($) |
0 |
-1,25,000 |
-1,25,000 |
1 |
15,000 |
-1,10,000 |
2 |
20,000 |
-90,000 |
3 |
90,000 |
0 |
4 |
15,000 |
15,000 |
Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)
= 2.00 Years + ($90,000 / $90,000)
= 2.00 Years + 1.00 Year
= 3.00 Years
= 3.0 Years
DECISION
The Both Investment Projects are acceptable, since it has the same payback period of 3.00 Years.