Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 7 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively. Time: 0 1 2 3 4 5 6 Cash flow: −$5,100 $1,240 $2,440 $1,640 $1,560 $1,440 $1,240 Use the payback decision rule to evaluate this project

Answer 1

Years	Cash outflow/ Inflow	Required IRR		Discounted cash flow
0	-5100	7%
1	1240		107%	1158.88
2	2440		114%	2131.19
3	1640		123%	1338.73
4	1560		131%	1190.12
5	1440		140%	1026.70
6	1240		150%	826.26
From above it is evident that at 7% IRR, discounted cash flow covers the outflow within 4 years against maximum allowable pay back of 4.5 years. Therefore decision rest in favor and meet required criteria of payback within 3.5 years and discounted payback within 4.5 years