Project A has annual cash flows of $200.00 for the next three years. Project B has annual cash flows of $100.00 for the next three years and then annual cash flows of $500.00 for the following four years. Assuming both projects have an initial cost of $500.00, which project is better based on the payback period criteria?

Question

Quizplus · Accepted Answer

Payback period is the amount of time it takes for a project to recoup its initial investment. In this case, both projects have an initial cost of $500.00.

Project A has annual cash flows of $200.00 for the next three years, so it would take 2.5 years to recoup the initial investment (i.e. $500.00/$200.00).

Project B has annual cash flows of $100.00 for the next three years and then annual cash flows of $500.00 for the following four years. This means it would take 1.5 years to recoup the initial investment on the first set of cash flows (i.e. $500.00/$300.00) and an additional 1.4 years to recoup the investment on the second set of cash flows (i.e. $200.00/$500.00). Therefore, the total payback period for Project B is 2.9 years.

Since Project A has a shorter payback period than Project B, it is the better choice based on the payback period criteria.

Project a Has Annual Cash Flows of $200