Problem: Diaz Camera Company is considering two investments, both of which cost $10,000. The cash flows are illustrated below:
Year Project A Project B
1 $6,000 $5,000
2 4,000 3,000
3 3,000 8,000
a) Which of the two projects should be chosen based on the payback method?
b) Which of the two projects should be chosen based on the net present value method? Assume a cost of capital of 10 percent.
c) Should a firm normally have more confidence in answer a or b?