A company is evaluating 3 possible investments. Each uses straight-line depreciation. See data below: What is the payback period for Project C?

Question

A company is evaluating 3 possible investments. Each uses straight-line depreciation. See data below:  What is the payback period for Project C?

Quizplus · Accepted Answer

The payback period for Project C can be calculated using the formula:
Payback period = Initial investment / Annual cash flow
For Project C, the initial investment is $80,000 and the annual cash flow is $40,000. Therefore, the payback period is:
Payback period = $80,000 / $40,000 = 2 years
However, since the cash flows are equal over the 4-year period, we need to take into account the partial year for the cash flow to be greater than the initial investment. The cumulative cash flow at the end of the second year is $80,000, which is equal to the initial investment. Therefore, the payback period for Project C is between 2 and 3 years. Looking at the table, we can see that the cumulative cash flow at the end of the third year is $120,000, which is greater than the initial investment. Therefore, the payback period for Project C is between 2 and 3 years, but less than 3 years. The closest option is A, which is 3.5 years.

Regarding the best choice(s), it depends on the investment criteria and the company's goals.

If we consider the simple payback method, the best option is Project A, as it has the shortest payback period of 2 years. However, this method does not take into account the time value of money or the cash flows beyond the payback period.

If we consider the net present value (NPV), assuming a discount rate of 10%, the best option is Project B. It has the highest NPV of $29,945, which means that the present value of the future cash flows is greater than the initial investment.

If we consider the internal rate of return (IRR), Project B is again the best option, as it has the highest IRR of 15.56%, which means that the project generates a return higher than the discount rate.

Therefore, the best choice(s) depend on the investment criteria and the company's goals.

A Company Is Evaluating 3 Possible Investments