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Payback and Net Present Value

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X-treme Vitamin Company is considering two investments, both of which cost
$10,000. The cash flows are as follows:
Year Project A Project B
1 . . . . . . . . . . $12,000 $10,000
2 . . . . . . . . . . 8,000 6,000
3 . . . . . . . . . . 6,000 16,000
a. Which of the two projects should be chosen based on the payback method?
b. Which of the two projects should be chosen based on the net present value
Method? Assume a cost of capital of 12 percent.
c. Should a firm normally have more confidence in answer a or answer b?

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Solution Summary

The solution explains how to calculate the payback period and net present value of the project

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In Payback method, we find the time taken to recover the initial investment. For Project A, the initial investment is 10,000. In the first year the inflow is 12,000. The inflow is higher than the initial investment, the payback is less than a year. Assuming that the flows are even throughout the year, we can say that the ...

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