A company is considering two projects. Project 1 has an initial investment of $60,000 and expected cash inflows of $20,000 each year for 5 years. Project 2 has an initial investment of $80,000 and expected cash inflows of $20,000 each year for 10 years. Using the payback period as the evaluation method, which investment should be chosen by management?

Project 1 with payback period of 3 years

Project 1

Explanation:

The computation of the payback period is shown below:

As we know that

Payback period = Initial investment : Net cash flow

For project 1

The payback period would be

= $60,000 : $20,000

= 3 years

For project 2

The payback period would be

= $80,000 : $20,000

= 4 years

Based on the payback period, project 1 should be chosen as the initial amount would be recovered in 3 years instead of 4 years shown in project 2