Use the information for the question below. Project A Project B Time 0 -$10,000 -$10,000 Time 1 $5,000 $4,000 Time 2 $4,000 $3,000 Time 3 $3,000 $10,000
If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will WiseGuy Inc. prefer?
a. Project A and Project B have the same ranking,
b. Project A
c. Cannot calculate a payback period without a discount rate.
d. Project B

The correct option is d. Project B.

Step-by-step explanation:

Note: See the attached excel file for the calculation of the Cumulative Cash Flows of Projects A and B.

Payback period refers to the number of time or period that is needed to recoup the amount of money spent a project. The

payback period rule states that when considering two or more projects, a project with the shortest payback period should be selected.

Payback period can be calculated as follows:

Payback period = Time before full recovery + (Unrecovered cost at start of the time of full recovery / Cash flow during the time of full recovery) ………………. (1)

Using the information in the excel file (in red color), equation (1) can be calculated for Project A and Project B as follows:

Project A payback period = 2 + ($1,000 / $3,000) = 2.33

Project B payback period = 2 + ($3,000 / $10,000) = 2.30

Since the payback period of Project B payback period which is 2.30 is lower than the Project A payback period of 2.33, Project B should be selected.

Therefore, the correct option is d. Project B.