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:YearProject AProject B1$5,000,000$20,000,0002$10,000,000$10,000,0003$15,000,000$8,000,0004$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.

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

 

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

 

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

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.

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Step 2

Working Note:

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Step 3

Project B:

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

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