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3 November, 01:44

Coffer Co. is analyzing two projects for the future. Assume that only one project can be selected. Project X Project Y Cost of machine $ 77,000 $55,000 Net cash flow: Year 1 28,000 2,000 Year 2 28,000 25,000 Year 3 28,000 25,000 Year 4 0 20,000 If the company is using the payback period method and it requires a payback of three years or less, which project should be selected?

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  1. 3 November, 04:53
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    Hence, Project X should be selected because it has a payback period of 2 years 9 months which is less that the target payback period of 3 years

    Explanation:

    The payback period is the estimated length of time in years it takes

    the net cash inflow from a project to equate and recoup the the initial cost

    Where a project is expected to generate a series of equal annual net cash inflow, the payback period can be calculated as:

    Project X

    Initial Project Cost = 77,000

    At the end of the 2nd year the total amount recouped would have = 28,000 + 28000 = 56,000

    Hence,

    Payback period = 2 years + (77,000-56,000) / 28,000 * 12 months

    = 2 years 9 months

    Project Y

    At the end of 3rd year the total amount recouped would have

    = 2,000 + 25,000 + 25,000 = 52,000

    Payback period = 3 years + (55,000-52,000) / 20,000 * 12 months

    = 3 years, 1.8 months

    Decision:

    The project with a payback period less than or equal to the target payback period of 3 years should be accepted. Otherwise, it should be rejected.

    Hence, Project X should be accepted because it has a payback period of 2 years 9 months which is less that the target payback period of 3 years
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