Question

# You are considering a project with the following set of cash flows: Cash flow 0 -5,500...

You are considering a project with the following set of cash flows:
 Cash flow 0 -5,500 1 2,000 2 3,000 3 1,000 4 2,000

a. What is the payback period of this project? If the pre-specified cut off is 3 years, should this project be accepted?

b. What is the discounted payback period of this project? If the pre-specified cut off is 3 years, should this project be accepted? The discount rate is 10%.

a.

 Year Cash flows Cumulative Cash flows 0 (5500) (5500) 1 2000 (3500) 2 3000 (500) 3 1000 500 4 2000 2500

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=2+(500/1000)=2.5 years

Hence since payback is less than 3 years;project should be accepted.

2.

 Year Cash flows Present value@10% Cumulative Cash flows 0 (5500) (5500) (5500) 1 2000 1818.18 (3681.82) 2 3000 2479.34 (1202.48) 3 1000 751.31 (451.17) 4 2000 1366.03 914.86(Approx).

Hence discounted payback=3+(451.17/1366.03)

=3.33 years

Hence since discounted payback is greater than 3 years;project should be rejected.

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