Question

Assume a $95,000 investment and the following cash flows for two alternatives.

Year	Investment A			Investment B
1	$	35,000		$	40,000
2		30,000			35,000
3		20,000			25,000
4		20,000			—
5		20,000			—

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 $20,000,000 instead of $20,000, would your answer change under the payback method?
  

	Yes
	No

Answer 1

a.Investment A

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                              = 3 years + $10,000/ $20,000

                              = 3 years + 0.50

                              = 3.50 years.

Investment B

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                              = 2 years + $20,000/ $25,000

                              = 2 years + 0.80

                              = 2.80 years.

b.I would select Investment B under the payback method since it has the shorter payback period.

c.If the cash inflow was $20,000,000 instead of $20,000 for investment A, the answer would not change the payback period since the payback period for investment A was 3.50 years.

In case of any query, kindly comment on the solution.