Question

Asked Nov 17, 2019

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Your company is currently considering two investment projects. Each project requires an upfront expenditure of $25 million. You estimate that the cost of capital is 10% and the investments will produce the following after tax cash flows:

Year |
Project A |
Project B |

1 |
$5,000,000 |
$20,000,000 |

2 |
$10,000,000 |
$10,000,000 |

3 |
$15,000,000 |
$8,000,000 |

4 |
$20,000,000 |
$6,000,000 |

- a) Calculate the payback period for both projects, then compare to identify which project the firm should undertake.

b) Evaluate the advantages and disadvantages of using the payback method in investment decisions and assess the situations where it should be used.

Step 1

- a)

**Calculation of Payback Period:**

The payback period for Project A is ** 2.67 years** and Project B is

The discounted payback period for Project A is ** 3.07 years** and Project B is

**Excel Spreadsheet:**

Step 2

**Excel Workings:**

Step 3

- b)

**The advantages of the payback period is as follows:**

- Highly convenient and easy to use
- Highly convenient to understand
- Able to take a decision quickly
- Gives more preference for liquidity
- Helpful in case of uncertainty

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