Question

Assume a $170,000 investment and the following cash flows for two products: Year Product X Product Y 1 $ 40,000 $ 60,000 2 60,000 70,000 3 50,000 30,000 4 40,000 40,000
a. Calculate the payback for products X and Y. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

b. Which alternative would you select under the payback method

Answer 1

Answer:

a. Product X = 3.50 years

   Product Y = 3.25 years

b. Product Y

Explanation:

The cash flows for the two products as well as the balance at the end of each year is given as follows:

$Initial\ balance = -170,000\\\\\begin{array}{ccccc}Year&Product\ X&Product\ Y& Balance\ X& Balance\ Y\\1&40,000&60,000&-130,000&-110,000\\2&60,000&70,000&-70,000&-40,000\\3&50,000&30,000&-20,000&-10,000\\4&40,000&40,000&20,000&20,000\end{array}$

For both products, the payback period is reached between the third and fourth year.

Product X:

$Payback = 3+\frac{20,000}{40,000} = 3.50\ years$

Product Y:

$Payback = 3+\frac{10,000}{40,000} = 3.25\ years$

Under the payback method, the alternative that presents the shortest payback period should be selected. Therefore, Product Y should be selected.