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. [Note: you are supposed to show every step of your calculation and interpret the result.]

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Asked Nov 15, 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. [Note: you are supposed to show every step of your calculation and interpret the result.]

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Expert Answer

Step 1

Hence, cumulative inflows are ascertained by adding the cash inflows of one year with the cash flows of the next year

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Project A Year Cash inflows Cumulative cash inlfows $500,000 $1,500,000 $3,000,000 $5,000,000 $500,000 $1,000,000 $1,500,000 $2,000,000 4

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Step 2

Hence, payback period for Project B is 2.67 years which is ascertained by dividing the difference of cash outlay and cumulative cash inflows with the difference of cumulative cash inflows immediate larger than cash outflows and cumulative cash inflows and adding the year when cash outlay comes under the cumulative cash inflows

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$2,500,000-$1,500, 000 $3,000,000-$1,500, 000 Payback period 2+ $1,000,000 2 $1,500,000 =2.67 years

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Step 3

Hence, cumulative inflows are ascertained by adding the cash in...

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Project B Cash inflows Cumulative cash inlfows $2,000,000 $3,000,000 $3,800,000 $4,400,000 Year $2,000,000 $1,000,000 $800,000 2 3 4 $600,000

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