Steak House Farms plans to invest in one of two animal farming business with a Ghc 1 million loan sourced from from GCB. Investing in Pig farming will cost 105,000 while the poultry business will cost Ghc100,000. The pig farming business has a lifespan of 5 years while the poultry farm will last for 6 years. The poultry cage would be sold for a scrap which will fetch Steve Ghc 40000. The year end cash flows from the two farms are shown in the table below.Period123456Pig farming2500045000400002000019000Poultry farming300005000050000500002700032,000Assume interest rate to be 5 percent Which of the two farming businesses would you recommend to Steak House Farm using the payback period technique? Use 1 and 2 to represent pig farming and poultry farming respectively Blank 1. Fill in the blank, read surrounding text.
Question
Steak House Farms plans to invest in one of two animal farming business with a Ghc 1 million loan sourced from from GCB. Investing in Pig farming will cost 105,000 while the poultry business will cost Ghc100,000. The pig farming business has a lifespan of 5 years while the poultry farm will last for 6 years. The poultry cage would be sold for a scrap which will fetch Steve Ghc 40000. The year end cash flows from the two farms are shown in the table below.Period123456Pig farming2500045000400002000019000Poultry farming300005000050000500002700032,000Assume interest rate to be 5 percent Which of the two farming businesses would you recommend to Steak House Farm using the payback period technique? Use 1 and 2 to represent pig farming and poultry farming respectively Blank 1. Fill in the blank, read surrounding text.
Solution
The payback period is the time it takes for an investment to generate an amount of income or cash equal to the cost of the investment. The investment with the shorter payback period is usually considered the better option because it allows the investor to recover their initial outlay sooner, reducing risk.
Let's calculate the payback period for both options:
- Pig Farming: The initial investment is Ghc 105,000. The cash flows for each year are as follows: 25,000, 45,000, 40,000, 20,000, and 19,000.
Year 1: 105,000 - 25,000 = 80,000 Year 2: 80,000 - 45,000 = 35,000 Year 3: 35,000 - 40,000 = -5,000
So, the payback period for the pig farming is somewhere in the third year.
- Poultry Farming: The initial investment is Ghc 100,000. The cash flows for each year are as follows: 30,000, 50,000, 50,000, 50,000, 27,000, and 32,000.
Year 1: 100,000 - 30,000 = 70,000 Year 2: 70,000 - 50,000 = 20,000 Year 3: 20,000 - 50,000 = -30,000
So, the payback period for the poultry farming is also somewhere in the third year.
However, the poultry farming business generates a higher negative cash flow in the third year, which means it pays back the initial investment faster than the pig farming business. Therefore, using the payback period technique, I would recommend Steak House Farm to invest in the poultry farming business (2).
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