Question

Stenson, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available. Year Cash Flow (A) Cash Flow (B) 0 –$ 75,000 –$ 125,000 1 33,000 29,000 2 36,000 32,000 3 19,000 35,000 4 9,000 240,000 a. What is the payback period for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b. Which, if either, of the projects should the company accept?

Answer 1

Answer:

a.

Paypack period for project A = 2.32 years

Paypack period for project B = 3.12 years

b.

Because Stenson, Inc., imposes a payback cutoff of 3 years, the company should accept project A.

Explanation:

Firstly, let recall the nature of paypack period. Paypack period is the duration of time it take to recover initial investment in a project. Please note that paypack period concept does not take time value of money into consideration.

Let look at project A: Initial investment  = 75,000. Cummulative cashflow until year 2 is 33,000 + 36,000 = 69,000. So, now we know that the paypack period is "2 year + something" or

Paypack period for project A = 2 + (75,000 - 69,000)/19,000 = 2.32 year.

Let look at project B: Initial investment  = 125,000. Cummulative cashflow until year 3 is 29,000 + 32,000 + 35,000 = 96,000. So, now we know that the paypack period is "3 year + something" or

Paypack period for project B = 3 + (125,000 - 96,000)/240,000 = 3.12 year.

Because Stenson, Inc., imposes a payback cutoff of 3 years, the company should accept project A.