Question

Madson Company is analyzing several proposed investment projects The firm has resources only for one project Project P Project Q Project R Project S Project T Cost of investment $32,000 $38,200 $57,100 $47,400 $53,000 Net cash flow Year 1 $5,200 $3,200 $4,300 $26,000 $15,900 Year 2 $9,600 $15,300 $16,900 $8,400 $15,800 Year 3 $12,700 $14,700 $21,000 $6,400 $16,100 Year 4 $15,300 $19,300 $31,000 $4,300 $11,000 Year 5 $52,000 $2,100 $10,000 The company uses the payback period method for making capital investment decisions. On the basis of this decision model, which project should be selected? (Ignore taxes.) a. Project T b. Project Q c. Project P d. Project R e. None

Answer 1

Answer:

Madison Company

On the basis of the payback period decision model, the project that should be selected is:

c. Project P

Explanation:

a) Data and Analysis:

                                 Project P   Project Q   Project R   Project S   Project T

Cost of investment  $32,000    $38,200    $57,100    $47,400   $53,000

Net cash flow

Year 1                         $5,200      $3,200      $4,300   $26,000    $15,900

Year 2                        $9,600     $15,300    $16,900     $8,400     $15,800

Year 3                       $12,700     $14,700    $21,000     $6,400      $16,100

Year 4                       $15,300    $19,300     $31,000     $4,300     $11,000

Year 5                      $52,000     $2,100     $10,000

Total net cash flow $94,800   $54,600    $83,200    $45,100    $58,800

                                 Year 4       Year 4        Year 4       Unable      Year 4

b) While four of the five projects pay back within Year 4, Project P has the added advantage of more total cash inflows.  It is followed closely by Project R.  The payback period as a capital appraisal method relies on counting the years or periods when the project's investment will be recovered. The payback period method does not evaluate projects based on the time value of money unless the modernized discounted payback period method is used.