Considering the unequal investments, which of the following techniques would be most approprlate for choosing between Investment A and Investment B?
Considering the unequal investments, which of the following techniques would be most approprlate for choosing between Investment A and Investment B?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
Transcribed Image Text:**Garrison Company Investment Opportunities**
Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below:
| Year | Investment A | Investment B |
|------|--------------|--------------|
| 0 | $(4,900) | $(5,850) |
| 1 | 1,960 | 2,940 |
| 2 | 1,960 | 1,960 |
| 3 | 1,960 | 1,960 |
| 4 | 1,960 | 980 |
**Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B?**
**Multiple Choice Options:**
- ( ) Payback method
- ( ) Present value index
- ( ) Net present value method
- ( ) None of these answers is correct
**Explanation:**
This table outlines the cash flows associated with two different investments over a four-year period. The initial investment (Year 0) for Investment A is $4,900, while for Investment B, it is $5,850. The subsequent cash flows for both investments are detailed for each year from Year 1 to Year 4.
The accompanying multiple-choice question asks which financial technique would be most appropriate for comparing these two unequal investments. The options provided include methods commonly used in capital budgeting.
Expert Solution
Step 1
Payback Period:
- It is the period in which the project recovers the cash outflow.
Net Present Value:
- It is the difference between the cash outflows and the discounted cash inflows. The common rule for NPV is to accept those projects with positive cash flows and reject those projects with negative cash flows.
Present value Index:
- It is computed as the ratio of the NPV to the initial cash outflow of the project.
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