Question

Question: Using payback to make capital investment decisions Consider the following three projects. All three have an initial investment of \(800,000.

Net Cash Inflows
	Project L		Project M		Project N
Year	Annual	Accumulated	Annual	Accumulated	Annual	Accumulated
1	\) 100,000	\( 100,000	\) 200,000	\( 200,000	\) 400,000	$ 400,000
2	100,000	200,000	250,000	450,000	400,000	800,000
3	100,000	300,000	350,000	800,000
4	100,000	400,000	400,000	1,200,000
5	100,000	500,000	500,000	1,700,000
6	100,000	600,000
7	100,000	700,000
8	100,000	800,000

Requirements

1. Determine the payback period of each project. Rank the projects from most desirable to least desirable based on payback.
2. Are there other factors that should be considered in addition to the payback period?

Short answer

Answer

1. The most alluring project is Project N with the slightest payback period, and the least alluring project is Project L with a payback period of 8 a long time.
2. ARR, NPV, IRR and profitability index should be considered.

Step-by-step solution

Meaning of Payback period

The payback period is the time it takes for a trade to recoup its initial investment. The project with the shortest payback period is the most appealing. The loan with the shortest payback time is the most appealing.

Determining payback and ranking each project.

The initial investment of $800,000 in Project L will be returned in 8 years, resulting in an 8-year payback time.

The initial investment of $800,000 in Project M will be returned in three years, resulting in a three-year payback time.

The initial investment of $800,000 in Project N will be returned in two years, resulting in a two-year payback time.