Question

Coffer Co. is analyzing two projects for the future. Assume that only one project can be selected. Project X Project Y Cost of machine $ 77,000 $55,000 Net cash flow: Year 1 28,000 2,000 Year 2 28,000 25,000 Year 3 28,000 25,000 Year 4 0 20,000 If the company is using the payback period method and it requires a payback of three years or less, which project should be selected?

Answer 1

Answer:

Hence, Project X should be selected because it has a payback period of 2 years 9 months which is less that the target payback period of 3 years

Explanation:

The payback period is the estimated length of time in years it takes  

the net cash inflow from a project to equate and recoup the the initial cost  

Where a project is expected to generate a series of equal annual net cash inflow, the payback period can be calculated as:

Project X

Initial Project Cost= 77,000

At the end of the 2nd year the total amount recouped would have = 28,000 +28000 = 56,000

Hence,

Payback period = 2 years + (77,000-56,000)/28,000× 12 months

                        = 2 years 9 months

Project Y

At the end of 3rd year the total amount recouped would have

= 2,000 + 25,000 + 25,000 = 52,000

Payback period = 3 years + (55,000-52,000)/20,000 × 12 months

                          = 3 years , 1.8 months

Decision:

The project with a payback period less than or equal to the target payback period of 3 years should be accepted. Otherwise, it should be rejected.

Hence, Project X should be accepted because it has a payback period of 2 years 9 months which is less that the target payback period of 3 years