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Long-term investment decision, payback method Personal Finance Problem Bill Williams has the opportunity to invest in project A that costs $7,400 today and promises to pay $2,300, $2,500, $2,500, $2,100 and $1,700 over the next 5 years
Long-term investment decision, payback method Personal Finance Problem Bill Williams has the opportunity to invest in project A that costs $7,400 today and promises to pay $2,300, $2,500, $2,500, $2,100 and $1,700 over the next 5 years. Or, Bill can invest $7,400 in project B that promises to pay $1,300, $1,300, $1,300, $3,400 and $4,100 over the next 5 years. (Hint: For mixed stream cash inflows, calculate cumulative cash inflows on a year-to-year basis until the initial investment is recovered.)
a. How long will it take for Bill to recoup his initial investment in project A? b. How long will it take for Bill to recoup his initial investment in project B? c. Using the payback period, which project should Bill choose? d. Do you see any problems with his choice?
Expert Solution
a). Payback period for project A = 3.05 years
b). Payback period for project B = 4.02 years
c).Based on the payback period Bill should choose the project A because it has lower payback period than project B.
d). Yes there is the problem with the choice. Because the payback period is not best option of selection of project because this method does not consider time value of money and the cash flow after payback period.
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