De Luca Company

11-47

De Luca Company is considering two possible investments, each of which requires an initial investment of $12,000. Investment A will provide a cash flow of $3,000 at the end of each year for 4 years. Investment B will provide a cash flow of $2,000 at the end of each year for 10 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 desired rate of return 5%. Which investment is most desirable using the NPV method?

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