The Payback Period For Project

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a) Based on payback period, the payback period for Project (A) is 2.66 years and the payback period for Project (B) is 2.02 years. That means Project (A) will recoup its initial investment in 2.66 years and Project (B) will recoup its initial investment in 2.02 years. The company should choose Project (B) because the payback period for Project (B) is shorter than the payback period for Project (A) and is less than the 4 years maximum payback requires by the company. The shorter and quickest the payback period of a project and with a payback period less than a specified number of years should be accepted (Kaplan Higher Education Study Guide, 2015, p. 74). In addition, the project with a shortest payback period has less threat than with the project with longer payback period. They allow the company to regain the investment more rapidly so that the company can reinvest the money somewhere else. The payback period represents the total of time that it takes for a Capital Budgeting project to recover its primary cost.

b) Based on Net Present Value (NPV), The NPV for Project (A) is $21,152.94 and the NPV for Project (B) is $7,783.10. The company should choose Project (A) because Project (A) has the larger NPV compared to Project (B). The general rule is that when NPV is positive, the project should be accepted because projects with a positive NPV are expected to increase the value of the firm or shareholder wealth, on the other hand, when the NPV is negative, the project should not be undertaken because the investment will not add value to the firm (Kaplan Higher Education Study Guide, 2015, p. 71); in the case of mutually exclusive projects, the project with the highest Net Present Value should be accepted. Thus, NPV makes the decisio...

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...of money and the value of cash flows in future periods. In addition, the NPV approach has no significant flaws (Kaplan Higher Education Study Guide, 2015, p. 94) and is the desired method for appraising projects because it considers risk and the time value of money, and has no random cut-off. NPV is easy to use, easily comparable, and customizable. Only if all alternatives are discounted to the same point in time, NPV allows for simple comparison between investment alternatives. It provides clear-cut decision suggestion for investments. The NPV rule also effortlessly handles both mutually exclusive and independent projects compared to IRR which can’t be used for exclusive projects or those of different period of time, IRR may exaggerate the rate of return and also profitability index which may not give the right choice when used to compare mutually exclusive projects.

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