Q2SE - Horngren'S Financial And Managerial Accounting

Question

S26-2 Using payback to make capital investment decisions 

Carter Company is considering three investment opportunities with the following payback periods:

	Project A	Project B	Project C
Payback period	2.7 years	6.4 years	3.8 years

 

Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.

Step-by-Step Solution

Answer

Rank	Project
1	A
2	C
3	B

Step 1: Definition of Capital Investment

The investment made by the business entity to acquire the fixed/plant assets to be employed in the business operations is known as capital investment. 

Step 2: Ranking of projects

The payback period defines the period in which the project will repay the amount initially invested. Project A is given 1^st rank because it will repay the amount at the earliest compared to other projects. At the same time, project B is provided with 3^rd rank because it will repay the initial investment after 6.4 years which is higher than the other two projects.