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What is the payback period of these investment options?

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The Short-Line Railroad is considering a $100,000 investment in either of two companies. The cash flows are as follows:

Year Electric Co. Water Works
1 $70,000 $15,000
2 15,000 15,000
3 15,000 70,000
4-10 10,000 10,000

a. Using the payback method, what will the decision be?
b. Explain why the answer in part a can be misleading.

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Solution Summary

The solution explains the use of payback method in 200 words with the answers.

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a. Payback is the time taken to recover the original investment. The investment is $100,000. For Electric Co. , the cash flows total to 100,000 in 3 years and so the payback is 3 years. For Water Works the cash flows total to 100,000 in 3 years and so the payback is 3 years. ...

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