Question 2 The cash flows for two alternatives are as follow

Question 2 The cash flows for two alternatives are as follows: Year Alternative A 30,000 12,000 9,000 6,000 3,000 Alternative B 35,000 1,000 4,000 7,000 10,000 13,000 6.000 19,000 22.000 (a) Based on payback period, which alternative should be selected? (b) Using present worth analysis, and a 12% interest rate which alternative should be selected? (c) If the answers in (a) and (b) differs, explain why?

Solution

(Question 2)

(a) Payback period (PBP) is the time by when a project\'s cumulative cash flows equal zero.

For Alternative A, PBP is 4 years. For Alternative B, PBP is 5 years. Since alternative A has lower PBP, this should be selected.

(b) Present worth (PW) of both alternatives is computed as follows.

Since alternative B has higher (and positive) PW, this should be selected.

(c) As per PBP method, Alternative A is selected and as per PW method, alternative B is preferred. This is because alternative A has higher cash flows in earler years and alternative B has higher cash flows in later years, which are ignored by the PBP Method.

NOTE: As per Chegg answering guidelines, 1st question is answered in full.

Alternative - A
Year	Cash flow	Cumulative cash flow
0	-30,000	-30,000
1	12,000	-18,000
2	9,000	-9,000
3	6,000	-3,000
4	3,000	0
Alternative - B
Year	Cash flow	Cumulative cash flow
0	-35,000	-35,000
1	1,000	-34,000
2	4,000	-30,000
3	7,000	-23,000
4	10,000	-13000
5	13,000	0