Explore BrainMass
Share

Calculating Payback Period & Comparing Investment Criteria

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

(See attached file for full problem descriptions)

© BrainMass Inc. brainmass.com October 24, 2018, 7:52 pm ad1c9bdddf
https://brainmass.com/economics/investments/calculating-payback-period-comparing-investment-criteria-81315

Attachments

Solution Preview

Question 1

Payback (PB) calculation will give us an idea on how long it will take
for a project to recover the initial investment.
Then if:
Y = the year before full recovery of investment I;
U = Unrecovered cost at the start of last year;
CFi = CF of the year Y+1;

PB = Y + U/CFi

-Project A:

CFi = $18,000
I = $38,000
After the year 2 we will have recovered only $35,000 and we will
finish to recover the investment during the year 3, then:
Y = 2
and
U = $38,000 - $35,000 = $3,000
PB = 2 + 3,000/18,000 = 2.16 years

-Project B:

CFi = $250,000
I = $70,000
After the year 3 we will have recovered only $45,000 and we will
finish to recover the investment during the year 4, then:
Y = 3
and
U = $70,000 - $45,000 = $25,000
PB = 3 + 25,000/250,000 = 3.1 years

Definition of Payback Criterion:
-Accept a project if its payback period is less than maximum
acceptable payback period.
-Reject a project if its payback period is longer than maximum
acceptable payback period.

The payback cutoff is 3 years. Since project A has a payback period of 2.16 years, it should be selected.

Question 2

a. If you apply the payback criterion, which investment will you choose? Why?

Payback (PB) calculation will give us an idea on how long it will take
for a project to recover the initial investment.
Then if:
Y = the year before full recovery of investment I;
U = Unrecovered cost at the start of last year;
CFi = CF of the year Y+1;

PB = Y + U/CFi

-Project A:

CFi = $425,000
I = $210,000
After the year 3 we will have recovered only $77,000 ...

Solution Summary

The solution explains how to calculate the payback period and decide between mutually exclusive projects,

$2.19
See Also This Related BrainMass Solution

Comparing Investment Criteria

Comparing Investment Criteria

Consider the following two mutually exclusive projects:
Year Cash Flow A Cash Flow B
0 -$257,851 -$31,827
1 25,500 11,483
2 57,000 12,954
3 51,000 11,412
4 405,000 9,674

Whichever project you choose, if any, you require a 15 percent return on your investment.

Required:

(a) The payback period for Projects A and B is and years, respectively. (Round your answers to 2 decimal places, e.g. 32.16.)

(b) The discounted payback period for Projects A and B is and years, respectively. (Round your answers to 2 decimal places, e.g. 32.16.)

(c) The NPV for Projects A and B is $ and $ , respectively. (Round your answers to 2 decimal places, e.g. 32.16.)

(d) The IRR for Projects A and B is percent and percent, respectively. (Do not include the percent sign (%). Round your answers to 2 decimal places, e.g. 32.16.)

(e) The profitability index for Projects A and B is and , respectively. (Round your answers to 3 decimal places, e.g. 32.161.)

(f) Based on your answers in (a) through (e), you will finally choose Project

View Full Posting Details