Question

Gander, Inc. is considering two projects with the following cash flows: Year Project X Project Y 0 ($100,000) ($100,000) 1 40,000 50,000 2 40,000 0 3 40,000 0 4 40,000 0 5 40,000 250,000 Gander uses the payback period method of capital budgeting and accepts only projects with payback periods of 3 years or less. a. If the projects are presented as stand-alone opportunities, which one(s) would Gander accept

Answer 1

Answer: Project X

Step-by-step explanation:

Project X payback period:

Payback period if the inflow is constant = Investment amount / Annual inflow

= 100,000 / 40,000

= 2.5 years

Project Y payback period:

= Year before payback + Amount remaining / Cash inflow in year of payback

Project Y makes no inflows from year 2 to 4 and brings in a substantial amount in year 5. Year before payback must be 4 years therefore.

Amount remaining = 100,000 - 50,000 in first year

= $50,000

= 4 + 50,000 / 250,000

= 4.2 years

Project X will be chosen as its payback period is less than 3 years.