Bailey Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $9,000,000; it will enable the company to increase its annual cash inflow by $3,000,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $18,000,000; it will enable the company to increase annual cash flow by $4,500,000 per year. This plane has an eight-year useful life and a zero salvage value.
a. Determine the payback period for each investment alternative and identify the alternative Bailey should accept if the decision is based on the payback approach.
b. Discuss the shortcomings of using the payback method to evaluate investment opportunities.