Answers to Mini-Case Questions
( Answers to Mini-Case Questions
BioCom Inc.
This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period, discounted payback period, NPV, IRR, MIRR, and PI.
1. Compute the payback period for each project.
|Time of Cash Flow |Nano Test Tubes |Microsurgery Kit |
|Investment |−$11,000.00 |−$11,000.00 |
|Year 1 | 2,000.00 | 4,000.00 |
|Year 2 | 3,000.00 | 4,000.00 |
|Year 3 | 4,000.00 | 4,000.00 |
|Year 4 | 5,000.00 | 4,000.00 |
|Year 5 | 7,000.00 | 4,000.00 |
Payback for Nano: cash flows for the first three years total $9,000. (11,000 − 9,000)/4,000 ’ .5, so payback for Nano is 3.5 years. For Microsurgery: cash flows for the first two years total $8,000. (11,000 − 8,000)/4,000 ’ 0.75, so payback for Microsurgery is 2.75 years. a. Explain the rationale behind the payback method.
The payback simply computes the break-even point for a project in terms of time rather than units or dollars. It is the amount of time required for a project to recover the initial investment.
b. State and explain the decision rule for the payback method.
The payback method implies that the sooner a project recovers the initial investment, the better. The choice of an acceptable payback period is arbitrary.
c. Explain how the payback method would be used to rank mutually exclusive projects.
For acceptable mutually exclusive projects, the one with the shortest payback period would be
BioCom Inc.
This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period, discounted payback period, NPV, IRR, MIRR, and PI.
1. Compute the payback period for each project.
|Time of Cash Flow |Nano Test Tubes |Microsurgery Kit |
|Investment |−$11,000.00 |−$11,000.00 |
|Year 1 | 2,000.00 | 4,000.00 |
|Year 2 | 3,000.00 | 4,000.00 |
|Year 3 | 4,000.00 | 4,000.00 |
|Year 4 | 5,000.00 | 4,000.00 |
|Year 5 | 7,000.00 | 4,000.00 |
Payback for Nano: cash flows for the first three years total $9,000. (11,000 − 9,000)/4,000 ’ .5, so payback for Nano is 3.5 years. For Microsurgery: cash flows for the first two years total $8,000. (11,000 − 8,000)/4,000 ’ 0.75, so payback for Microsurgery is 2.75 years. a. Explain the rationale behind the payback method.
The payback simply computes the break-even point for a project in terms of time rather than units or dollars. It is the amount of time required for a project to recover the initial investment.
b. State and explain the decision rule for the payback method.
The payback method implies that the sooner a project recovers the initial investment, the better. The choice of an acceptable payback period is arbitrary.
c. Explain how the payback method would be used to rank mutually exclusive projects.
For acceptable mutually exclusive projects, the one with the shortest payback period would be