P10–1 Payback period Jordan Enterprises is considering a capital

expenditure that requires

an initial investment of $42,000 and returns aftertax cash inflows
of $7,000 per year
for 10 years. The firm has a maximum acceptable payback period
of 8 years.
a. Determine the payback period for this project.
b. Should the company accept the project? Why or why not?

A:
initial investment $ 42,000
cash inflow $ 7,000
Playback period 6 YEARS
B: The company should accept the project , since 6 < 8

P10–2 Payback comparisons Nova Products has a 5-year maximum

acceptable payback
period. The firm is considering the purchase of a new machine and
must choose
between two alternative ones. The first machine requires an initial
investment of
$14,000 and generates annual after-tax cash inflows of $3,000 for each
of the next
7 years. The second machine requires an initial investment of $21,000
and provides
an annual cash inflow after taxes of $4,000 for 20 years.
a. Determine the payback period for each machine.

b. Comment on the acceptability of the machines, assuming that they

are inde-
pendent projects.

c. Which machine should the firm accept? Why?

d. Do the machines in this problem illustrate any of the weaknesses of

using pay-
back? Discuss.

A:
Mchine 1:
Initial investment $ 14,000
/ cash inflow $ 3,000
4.7 = 4 Years , 8 Months
A:
Machine 2:
Initial investment $ 21,000
/ cash inflow $ 4,000
5.3 = 5 Years , 3Months
B:
Only Machine 1 has a Payback period faster than 5 years and is acceptable.
C:
The firm will accept the first machine because the payback period of 4 years , 8 months is less than the 5 years max
payback required by nova product.
D:
Machine 2 has returns which last 20 years while machine one has only 7 years of return. Payback cannot consider
this difference ;it ignores all cash flows beyound the payback period.

P10–3 Choosing between two projects with acceptable payback periods Shell
Camping Gear, Inc., is considering two mutually exclusive projects. Each
requires an initial investment of $100,000. John Shell, president of the
company, has set a maximum payback period of 4 years. The after-tax cash
inflows associated with each project are shown in the following table:
416 PART 5 Long-Term Investment Decisions LG 2 Cash inflows (CFt)
Year Project A Project B
1 $10,000 $40,000
2 20,000 30,000
3 30,000 20,000
4 40,000 10,000
5 20,000 20,000
a. Determine the payback period of each project.
b. Because they are mutually exclusive, Shell must choose one. Which should
the company invest in?
c. Explain why one of the projects is a better choice than the other.

Part A:
Project A: Project B:
years1: Year 1:
cash inflows $ 10,000 cash inflows
- initial investment $ 100,000 initial investment
$ (90,000)
years 2: Year 2:
cash inflows $ 20,000 cash inflows
 initial investment $ 90,000 initial investment
$ (70,000)
Year 3 : Year 3:
cash inflows $ 30,000 cash inflows
initial investment $ 70,000 initial investment
$ (40,000)
Year 4: Year 4:
cash inflows $ 40,000 cash inflows
initial investment $ 40,000 initial investment
$ -
Both Project A and B have payback periods of exactly 4 years.
Part B: based on the minimum payback acceptance criteria of 4 years set by john shell, both project should be accepted ho
mutually exclusive projects john should accept project B.
Part C: project B is preferred over A becase the larger cash flows are in the early years if the project the quicker cash inflow

P10–4 Long-term investment decision, payback method Bill Williams has the
opportunity to invest in project A that costs $9,000 today and promises to pay
annual end-of- year payments of $2,200, $2,500, $2,500, $2,000, and $1,800
over the next 5 years. Or, Bill can invest $9,000 in project B that promises to
pay annual end-of-year payments of $1,500, $1,500, $1,500, $3,500, and $4,000
over the next 5 years.
a. How long will it take for Bill to recoup his initial investment in project A?
b. How long will it take for Bill to recoup his initial investment in project B?
c. Using the payback period, which project should Bill choose?
d. Do you see any problems with his choice?

PART A , B: Project A
Years Annual cash flow cumulative cash flow
0 $ 9,000 $ 9,000
1 $ 2,200 $ (6,800)
2 $ 2,500 $ (4,300)
3 $ 2,500 $ (1,800)
4 $ 2,000
5 $ 1,800
Total $ 11,000
Payback Period 3+1800/2000= 3.9 Years

Part C: The payback method would select Project A because its payback of 4.9 years is lower than project B payback of 4.25

Part D: one weakness of the payback method is that it disregards excepted future cashflow as in the case of project B.

P10–10 NPV—Mutually exclusive projects Hook

Industries is considering the replacemenof one of its old
drill presses. Three alternative replacement presses are
under consid-eration. The relevant cash flows associated
with each are shown in the followingtable. The firm’s cost
 P10–10 NPV—Mutually exclusive projects Hook
Industries is considering the replacemenof one of its old
drill presses. Three alternative replacement presses are
under consid-eration. The relevant cash flows associated
with each are shown in the followingtable. The firm’s cost
of capital is 15%.

Project X Project Y Cost of capital 15%

Ini. Invest $ (500,000) $ (325,000)
1 $ 100,000 $ 140,000 Accept Reject
2 $ 120,000 $ 120,000
3 $ 150,000 $ 95,000
4 $ 190,000 $ 70,000
5 $ 250,000 $ 50,000
IRR 16% 17%
Decision Accept Accept
 months is less than the 5 years maximun

of return. Payback cannot consider

$ 40,000
$ 100,000
$ (60,000)

$ 30,000
 $ 60,000
$ (30,000)

$ 20,000
$ 30,000
$ (10,000)

$ 10,000
$ 10,000
$ -

, both project should be accepted however sinve they are

if the project the quicker cash inflowoccur, greter their value.

Project B:
Annual cash flows cumulative cash flows
$ 9,000 $ 9,000
$ 1,500 $ (7,500)
$ 1,500 $ (6,000)
$ 1,500 $ (4,500)
$ 3,500 $ (1,000)
$ 4,000
Total $ 12,000
Payback period 4+1000/4000=4.25 Years

lower than project B payback of 4.25 years

hflow as in the case of project B.