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P10-3 Choosing Between Two Projects With Acceptable Payback Periods Conad, An Italian

Conad is considering two projects, A and B, that each require an initial investment of €1,000,000. Project A has cash inflows of €200,000 for years 1-4 and €190,000 for years 5-6, with a payback period of 5.05 years. Project B has cash inflows of €100,000 in year 1, €200,000 in year 2, €300,000 in year 3, and €400,000 in year 4, with a payback period of 4 years. Since Project B's payback period is less than the maximum of 5 years set by Conad, Project B is the project that Conad should invest in.

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344 views3 pages

P10-3 Choosing Between Two Projects With Acceptable Payback Periods Conad, An Italian

Conad is considering two projects, A and B, that each require an initial investment of €1,000,000. Project A has cash inflows of €200,000 for years 1-4 and €190,000 for years 5-6, with a payback period of 5.05 years. Project B has cash inflows of €100,000 in year 1, €200,000 in year 2, €300,000 in year 3, and €400,000 in year 4, with a payback period of 4 years. Since Project B's payback period is less than the maximum of 5 years set by Conad, Project B is the project that Conad should invest in.

Uploaded by

Sakibul Islam Sifat
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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P10-3

Choosing between two projects with acceptable payback periods Conad, an Italian
supermarket chain, is considering two mutually exclusive projects. Each project requires an
initial investment (CF 0 ) of €1,000,000. Francesco Puglies, the general director of Conad, has set
a maximum payback period of 5 years. The net receivable cash inflows associated with each
project are shown in the following table.

Cash inflows (CF 1)


Year Project A Project B
1 €200,000 €100,000
2 200,000 200,000
3 200,000 300,000
4 200,000 400,000
5 190,000 10,000
6 190,000 10,000
A . Determine the payback period of each project.

B . Because the projects are mutually exclusive, Conad must choose one. Which one should the
company invest in?

C . Explain why the payback period might not be the best method for choosing between projects.

Solution:

Calculation table for project A

Year CFBT CFAT Cumulative cash flow

01 200,000 200,000 200,000

02 200,000 200,000 400,000

03 200,000 200,000 600,000

04 200,000 200,000 800,000

05 190,000 190,000 990,000

06 190,000 190,000 11,80,000

We know,
Here,
NCO−C
PBP = A+ A = the years in which cumulative cash
D
flow is nearer to NCO =5
1000000−990000
= 5+
190000 NCO = Net cash outlay=1000000

=5+0.5 C =cumulative cash flow of the year


A=990000
=5.05 years
D= cash flow of the following year of A
Calculation table for project B

Year CFBT CFAT Cumulative cash flow

01 100,000 100,000 100,000

02 200,000 200,000 300,000

03 300,000 300,000 600,000

04 400,000 400,000 10,00,000

05 10,000 10,000 10,10,000

06 10,000 10,000 10,20,000

We know,
Here,
NCO−C
PBP = A+ A = the years in which cumulative cash
D
flow is nearer to NCO =3
1000000−60000
= 3+
400000 NCO = Net cash outlay=1000000

=3+1 C =cumulative cash flow of the year


A=600000
=4 years
D= cash flow of the following year of A

a) The company should invest in project B .because the payback period of project B is 4
years less than maximum payback period of (5) years.

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