Compare the two investment proposals below, using the payback period technique. The projected cost of each investment proposal is $100,000.
?
Project A
Project B
Year
(Cash Flow)
(Cash Flow)
1
$25,000
$25,000
2
20,000
20,000
3
10,000
40,000
4
10,000
30,000
5
—
10,000
?
What will be an ideal response?
Capital budgeting is used to compare alternatives so that the best investment decisions can be made. The total cash flow of Project A is only $65,000 from an investment cost of $100,000. The investment is unwise because the initial outlay will never be recovered. Project B is expected to generate $125,000 over its lifetime from an investment of $100,000, and the initial investment will be recovered in less than four years. Project B is the clear winner between the two alternatives.
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