Question

A company is considering two projects. project 1 has an initial investment of $60,000 and expected cash inflows of $20,000 each year for 5 years. project 2 has an initial investment of $80,000 and expected cash inflows of $20,000 each year for 10 years. using the payback period as the evaluation method, which investment should be chosen by management?multiple choice question.

O project 1 with total cash inflows of $100,000
O project 1 with payback period of 3 years
O project 2 with payback period of 4 years
O project 2 with total cash inflows of $200,000

Answer 1

The correct answer is option 2. Using the payback period method, Project 1 is the better option with a payback period of 3 years compared to Project 2's 4 years. Management should choose Project 1 as it recovers the initial investment faster.

Step-by-step explanation:

When evaluating investments using the payback period method, we look at how quickly the initial investment can be recovered through cash inflows. In this case, Project 1 has an initial investment of $60,000 and is expected to bring in $20,000 each year.

The payback period for this project is therefore 3 years ($60,000 / $20,000 per year), since that is the amount of time it will take for the cash inflows to cover the initial investment. Project 2, on the other hand, has a higher initial investment of $80,000 and also brings in $20,000 each year. The payback period for Project 2 is 4 years ($80,000 / $20,000 per year).

According to the payback period evaluation method, management should choose the investment with the shortest payback period when all other factors are equal. Therefore, the correct option to choose in this situation would be Project 1 with a payback period of 3 years.