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Stallone Company is considering two possible investments, each of which requires an initial investment of $36,000. Investment

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Stallone Company is considering two possible investments, each of which requires an initial investment of $36,000. Investment A will provide a cash flow of $4,000 at the end of each year for 20 years. Investment B will provide a cash flow of $4,500 at the end of each year for 8 years.

1. Determine the payback period for each investment. Which investment is most desirable using the payback method?

2. Compute the NPV of each investment using a required rate of return of 8%. Which investment is most desirable using the NPV method?

3. Explain why the payback method does not lead to an optimal decision for the Stallone Company.

Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...
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1 Investment A payback period 36000 4000 9 years Investment B payback period 36000 4500 8 ...View the full answer


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Introduction to Management Accounting

Introduction to Management Accounting

ISBN: 978-0133058789

16th edition

Authors: Charles Horngren, Gary Sundem, Jeff Schatzberg, Dave Burgsta

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NPV stands for \"Net Present Value,\" which is a financial concept used to determine the value of an investment or project. It measures the difference between the present value of cash inflows and the present value of cash outflows over a given period of time, using a specific discount rate. To calculate the NPV of an investment, you need to first estimate the cash inflows and outflows associated with the investment, and then discount them back to their present values using a discount rate. The discount rate represents the cost of capital or the expected rate of return required by investors. The formula for calculating NPV is: NPV = sum of (cash inflows / (1 + discount rate)^t) - sum of (cash outflows / (1 + discount rate)^t) Where: Cash inflows: the expected cash received from the investment Cash outflows: the expected cash paid out for the investment Discount rate: the required rate of return or the cost of capital t: the time period in which the cash flow occurs If the NPV is positive, it means that the investment is expected to generate a return higher than the required rate of return or the cost of capital, and it may be considered a good investment. If the NPV is negative, it means that the investment is not expected to generate a return higher than the required rate of return or the cost of capital, and it may be considered a bad investment.

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