Question

A company is considering two mutually exclusive projects. The firm has a 12% cost of capital , has estimated the cash flows as below: Project A Project B Initial Investment -$150,000 -$150,000 Year Cash Inflows 1 $ 45,000 $ 75,000 2 $ 45,000 $ 60,000 3 $ 45,000 $ 30,000 4 $ 45,000 $ 30,000 5 $ 45,000 $ 30,000 6 $ 45,000 $ 30,000 Calculate the payback period for each project. Which project is preferred according to this technique

Answer 1

Answer:

Project A = 4 years 4 months

Project B = 2 years 6 months

Explanation:

The payback period of a project is the length of time it takes for the cash flows to equal the amount of initial investment.

Project A ( $150,000) = $ 45,000 + $ 45,000  + $ 45,000 + $15,000 /  $ 45,000 x 12

                                    = 4 years 4 months

Project A ( $150,000) = $ 75,000 + $ 60,000  + $15,000 /  $ 30,000 x 12

                                    = 2 years 6 months