Answer:
Madison Company
On the basis of the payback period decision model, the project that should be selected is:
c. Project P
Explanation:
a) Data and Analysis:
                 Project P  Project Q  Project R  Project S  Project T
Cost of investment  $32,000   $38,200   $57,100   $47,400  $53,000
Net cash flow
Year 1 Â Â Â Â Â Â Â Â Â Â Â Â $5,200 Â Â Â $3,200 Â Â Â $4,300 Â $26,000 Â Â $15,900
Year 2 Â Â Â Â Â Â Â Â Â Â Â Â $9,600 Â Â $15,300 Â Â $16,900 Â Â $8,400 Â Â $15,800
Year 3 Â Â Â Â Â Â Â Â Â Â Â $12,700 Â Â $14,700 Â Â $21,000 Â Â $6,400 Â Â Â $16,100
Year 4 Â Â Â Â Â Â Â Â Â Â Â $15,300 Â Â $19,300 Â Â $31,000 Â Â $4,300 Â Â $11,000
Year 5 Â Â Â Â Â Â Â Â Â Â Â $52,000 Â Â $2,100 Â Â $10,000
Total net cash flow $94,800 Â $54,600 Â Â $83,200 Â Â $45,100 Â Â $58,800
                 Year 4    Year 4     Year 4    Unable    Year 4
b) While four of the five projects pay back within Year 4, Project P has the added advantage of more total cash inflows. Â It is followed closely by Project R. Â The payback period as a capital appraisal method relies on counting the years or periods when the project's investment will be recovered. The payback period method does not evaluate projects based on the time value of money unless the modernized discounted payback period method is used.
The payback period method is a method that considers the number of months or years it takes to return the initial investment.
When more than one investment is being considered under payback period, the investment with the shortest payback period will be selected.
Since the net cash inflows of each year for each project is different, the following formula is used in the attached photo to calculate the payback period:
Payback period = A + (X / Y) ………………….. (1)
Where:
A = Year immediately preceding to year of recovery
X = Amount left to be recovered
Z = Cash inflow in the year of final recovery
Before equation (1) is used, cumulative net cash inflows is first calculated as done in the attached photo.
From the attached photo, we have:
Project P’s payback period = 3.29 years
Project Q’s payback period = 3.26 years
Project R’s payback period = 3.48 years
Project S’s payback period = after 5 years
Project T’s payback period = 3.47 years
Based on above the above, b. Project Q should be selected because it has the shortest payback period which is 3.26 years.
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