Munoz Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $15,660,000; it will enable the company to increase its annual cash inflow by $5,800,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $34,400,000; it will enable the company to increase annual cash flow by $8,600,000 per year. This plane has an eight-year useful life and a zero salvage value. Required Determine the payback period for each investment alternative and identify the alternative Munoz should accept if the decision is based on the payback approach. (Round your answers to 1 decimal place.)

To determine the payback period for each investment alternative, we must calculate the number of years it takes for the net cash inflows to recover the initial cost of investment.

1. First Airplane: - Cost of the airplane: $15,660,000 - Annual cash inflow: $5,800,000

The payback period for the first airplane is computed by dividing the cost of the airplane by the annual increase in cash flow:

Payback Period = Cost of Investment / Annual Cash Inflow = $15,660,000 / $5,800,000 = 2.7 years (rounded to 1 decimal place)

2. Second Airplane: - Cost of the airplane: $34,400,000 - Annual cash inflow: $8,600,000

The payback period for the second airplane is computed as follows:

Payback Period = Cost of Investment / Annual Cash Inflow = $34,400,000 / $8,600,000 = 4.0 years (rounded to 1 decimal place)

Now, to decide which investment to accept based on the payback approach, Munoz Airline Company would choose the one with the shortest payback period, since it indicates the time it takes to recover the initial investment.

Since the first airplane has a payback period of 2.7 years and the second airplane has a payback period of 4.0 years, Munoz should accept the first airplane as it recovers the investment quicker compared to the second airplane, assuming other factors such as risk, scale of operations, and cash flows beyond the payback period are not considered.

Extra: The payback period is a capital budgeting method that calculates the time required for an investment to generate enough cash flows to recover its initial cost. This method is quite straightforward and focuses only on the time aspect of recovering the investment, without considering the time value of money. This can be a drawback as the method neglects any benefits received after the payback period and does not account for the profitability or the return on investment.

Comparatively, there are other methods to evaluate investments, such as the Net Present Value (NPV), Internal Rate of Return (IRR), and the profitability index which do take into account the time value of money. These methods may lead to more informed financial decisions as they consider the entire cash flow stream associated with the project and the cost of capital.

For a student studying business or finance, it is essential to understand the limitations of each investment appraisal technique and when it is appropriate to use them. The choice of which technique to use can significantly impact the investment decisions a company makes, potentially affecting its long-term success and financial stability.