Calculate Payback Period for Project A and Project B
What is the payback period of each project?
Calculate the payback period for project A and project B based on the cash flow data provided.
Payback Period Calculation:
The payback period is the amount of time it takes for a project to recoup its initial investment. It is calculated by adding up the cash flows until the sum is equal to the initial investment.
Project A:
For project A, the payback period is 2 years. The initial investment of $340 is recouped by the end of year 2, with cash flows of $170 in year 1 and $170 in year 2.
Project B:
For project B, the payback period is 1.42 years. The initial investment of $340 is recouped in year 1 with a cash flow of $240, and an additional $100 is recouped in year 2. The remaining $40 needed to reach the initial investment is recouped in 0.42 years.
The payback period is an important financial metric used to assess the risk and return of a project. In this case, project B has a shorter payback period of 1.42 years compared to project A's payback period of 2 years. This indicates that project B recoups its initial investment faster than project A, making it a potentially more favorable investment option.
Investors and stakeholders often consider the payback period when evaluating project feasibility and profitability. A shorter payback period typically implies lower risk and quicker returns on investment.
It is crucial for businesses to analyze the payback period along with other financial metrics to make informed decisions regarding capital allocation and project prioritization.