Rashid Company, a software developer, has two investment opportunities, X and Y. Data for X and Y are given in Table 9.3. The payback period for project X is 2 years; for project Y it is 3 years. Strict adherence to the payback approach suggests that project X is preferable to project Y. However, if we look beyond the payback period, we see that project X returns only an additional $1,200 ($1,000 in year 3 + $100 in year 4 + $100 in year 5), whereas project Y returns an additional $7,000 ($4,000 in year 4 + $3,000 in year 5). On the basis of this information, project Y appears preferable to X. The payback approach ignored the cash inflows occurring after the end of the payback period.4
TABLE 9.3 | ||
Calculation of the Payback Period for Rashid Company’s Two Alternative Investment Projects | ||
 | Project X | Project Y |
Initial investment | $10,000 | $10,000 |
Year | Operating | cash inflows |
1 | $5,000 | $3,000 |
2 | 5,000 | 4,000 |
3 | 1,000 | 3,000 |
4 | 100 | 4,000 |
5 | 100 | 3,000 |
Payback period | 2 years | 3 years |
No comments:
Post a Comment