Question

Asked Oct 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

**1.a)**

**Computation of payback period for project A and project B:**

Hence, the payback period of project A is** 2.67 years.**

Step 2

**Working Note:**

Step 3

**Project B:**

Hence, the payback period of project B is** 1...**

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