Question

A company is considering two projects. Project A Project B Initial investment $200,000 $200,000 Cash inflow Year 1 $60,000 $90,000 Cash inflow Year 2 $60,000 $90,000 Cash inflow Year 3 $60,000 $40,000 Cash inflow Year 4 $60,000 $50,000 Cash inflow Year 5 $60,000 $70,000 What is the payback period for Project B? a. 4.5 years b. 3.5 years c. 2.5 years d. 2 years e. 3 years

Answer 1

Year	Cash flows	Cumulative Cash flows
0	(200,000)	(200,000)
1	90,000	(110,000)
2	90,000	(20,000)
3	40,000	20,000
4	50,000	70,000
5	70,000	140,000

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=2+(20,000/40,000)

=2.5 years

Answer 2

The payback period for Project B can be calculated by adding up the cash inflows until the initial investment is fully recovered.

Year 1: $90,000 - $200,000 = -$110,000 Year 2: $90,000 + (-$110,000) = -$20,000 Year 3: $40,000 + (-$20,000) = $20,000 Year 4: $50,000 + $20,000 = $70,000

Therefore, the payback period for Project B is 3 years (Option e).