The conference on evaluating capital projects has been very helpful. You have received a significant amount of information and multiple projects to evaluate to hone your skills. To adequately teach Grammy and the board you will need to answer several questions about the capital-budgeting process. You will do this in a business memo that is no more than four pages long.
Provide an evaluation of two proposed project, both with a 5-year expected lives and identical initial outlays of $110,000. Both of these projects involve additions to a highly successful product line, and as a result, the required rate of return on both projects has been established at 12 percent. The expected free cash flows from each project are as follows:
Project A Project B
Initial outlay -$110,000 -$110,000
Inflow year 1 20,000 40,000
Inflow year 2 30,000 40,000
Inflow year 3 40,000 40,000
Inflow year 4 50,000 40,000
Inflow year 5 70,000 40,000
c. What is the payback period on each project? If the organization imposes a 3-year maximum acceptable payback period, which of these projects should be accepted?
d. What are the criticisms of the payback period?