Multiple Choice QuestionA company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Using the payback period as the evaluation method, which investment should be chosen by management?Multiple choice question.Investment BInvestment ABoth investments have the same payback period.
Question
Multiple Choice QuestionA company is considering two capital investments. Each requires an initial investment of 5,000 each year for the 4 years for total cash inflows of 8,000; Year 2: 4,000; Year 4: 20,000. Using the payback period as the evaluation method, which investment should be chosen by management?Multiple choice question.Investment BInvestment ABoth investments have the same payback period.
Solution
The payback period is the time it takes for an investment to generate an amount of income or cash equal to the cost of the investment. It is a simple tool that tells you how long it will take to recoup your investment.
For Investment A, the payback period is 5,000 = 3 years.
For Investment B, the cash inflows are different each year. In the first year, you get 6,000 for a total of 15,000. It's only in the third year, when you get another 18,000) exceed your initial investment.
So, the payback period for Investment B is somewhere between 2 and 3 years.
Therefore, using the payback period as the evaluation method, management should choose Investment B.
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