Question

A23. (Capital budgeting—payback method) Allenby Corp. has $10 million to invest. Listed below are the expected future cash inflows to be received for four alternative investments, in millions of dollars.

Investment A,     Investment B,     Investment C,     Investment D
Year 1    7,     1,     0,     7
Year 2    1,     2,     0,     3
Year 3    2,     7,     3,     0
Year 4    2,     8,     7,     0
Year 5    2,     9,     10,     0

    A. Compare investments A and B.
        a. Compute the payback periods for Investments A and B.
        b. Which one would you pick, based only on payback period?
        c. Do you think one is a better investment?

    B. Compare investments C and D.
        a. Compute the payback periods
        b. Which one would you pick, based on the payback periods?
        c. Do you think this is the better investment? Why, or why not?

Answer 1

(A.a.) Payback peirod for Investment A and B.

1	7	7
2	1	2
3	2	6
4	2	8
5	2	10
15 Years		33 million
Average Return 33/15=2.2 Million
Payback period= Investment/return 10/2.2 = 4.545 Years

1	1	1
2	2	4
3	7	21
4	8	32
5	9	45
15 Years		103 Million
Average Return 103/15=6.866 Million
Payback period= Investment/return 10/6.87 = 1.45 Years

(A.b) As per payback period Investment B should be opt. (A.c) In Investment B return of investment is eariler then in Investment A option.

(B.a)

1	0	0
2	0	0
3	3	9
4	7	28
5	10	50
15 Years		87 million
Average Return 87/15=5.8 Million per Year
Payback period= Investment/return 10/5.8 = 1.72 Years

1	7	7
2	3	6
3	0	0
4	0	0
5	0	0
15 Years		13
Average Return 13/15=.87 Million per Year
Payback period= Investment/return 10/.87 = 11.49 Years

(B.b) As per payback period Investment C should be opt. (B.c) In Investment C return of investment is eariler then in Investment D option.

Best Investment is Investment B and worst Investment is Investment D.