Coffer Co.is analyzing two projects for the future.Assume that only one project can be selected. $\begin{array}{lrr}
&\underline { \text {Project X } }&\underline { \text {Project Y } }\
\text { Cost of } &\$ 68,000 & \$ 60,000\
\text { machine } \
\text { Net cash flow: } \
\text { Year 1 } & 24,000 & 4,000 \
\text { Year 2 } & 24,000 & 26,000 \
\text { Year 3 } & 24,000 & 26,000 \
\text { Year 4 } & 0 & 20,000
\end{array}$ If the company is using the payback period method and it requires a payback of three years or less, which project should be selected?
A)Project Y.
B)Project X.
C)Both X and Y are acceptable projects.
D)Neither X nor Y is an acceptable project.
E)Project Y because it has a lower initial investment.

Question

Coffer Co.is analyzing two projects for the future.Assume that only one project can be selected. $\begin{array}{lrr}
&\underline { \text {Project X   } }&\underline { \text {Project Y } }\
 \text { Cost of  } &\$ 68,000 & \$ 60,000\
 \text { machine } \
 \text { Net cash flow: } \
\text { Year 1 } & 24,000 & 4,000 \
\text { Year 2 } & 24,000 & 26,000 \
\text { Year 3 } & 24,000 & 26,000 \
\text { Year 4 } & 0 & 20,000
\end{array}$ If the company is using the payback period method and it requires a payback of three years or less, which project should be selected?
A)Project Y.
B)Project X.
C)Both X and Y are acceptable projects.
D)Neither X nor Y is an acceptable project.
E)Project Y because it has a lower initial investment.

Quizplus · Accepted Answer

To calculate the payback period, we will add up the net cash flows until we reach the initial investment of the project. 
For Project X,

Year 1: 24,000 
Year 2: 24,000 + 4,000 = 28,000 
Year 3: 24,000 + 26,000 = 50,000

We have reached the initial investment of $68,000 in the middle of year 3. Therefore, the payback period for Project X is 2.5 years.

For Project Y,

Year 1: 4,000 
Year 2: 4,000 + 26,000 = 30,000 
Year 3: 30,000 + 26,000 = 56,000 
Year 4: 56,000 + 20,000 = 76,000

We have reached the initial investment of $60,000 in the middle of year 3. Therefore, the payback period for Project Y is also 2.5 years.

Since both projects have a payback period of less than three years, they are both acceptable projects according to the payback period method. However, if we had to choose only one project based on the payback period, Project X would be a better choice because it has a higher net cash flow in the first year and will pay back the initial investment in the same amount of time as Project Y.

Coffer CoIs Analyzing Two Projects for the Future If the Company Is Using the Payback Period Method and One