Chapter 12, Problem 9P

a.

Summary Introduction

To calculate: The selection of the investment using the PBP method.

Introduction:

Pay-back period (PBP):

It is one of the methods of capital budgeting that helps evaluate the time period in which the amount of initial investment is recovered. The formula for the calculation of the PBP is shown below.

$\text{Pay-Back Period}=\text{Year}+\frac{\text{Initial Investment}-\text{Cumulative Cash Flow}}{\text{Cash FLow}}$

Here,

Year = The year in which the cumulative cash flow is close to and less than the initial investment.

Initial investment = The amount of the investment.

Cumulative cash flow = The cumulative cash flow is close to and less than the initial investment.

Cash flow = The cash flow of the next year from the “Year� used for the calculation.

b.

Summary Introduction

To explain: The reason why the answer of part (a) is misleading.

Introduction:

Pay-back period (PBP):

It is one of the methods of capital budgeting that helps evaluate the time period in which the amount of initial investment is recovered. The formula for the calculation of the PBP is shown below.

$\text{Pay-Back Period}=\text{Year}+\frac{\text{Initial Investment}-\text{Cumulative Cash Flow}}{\text{Cash FLow}}$

Here,

Year = The year in which the cumulative cash flow is close to and less than the initial investment.

Initial investment = The amount of the investment.

Cumulative cash flow = The cumulative cash flow is close to and less than the initial investment.

Cash flow = The cash flow of the next year from the “Year� used for the calculation.