Question

Compute the Discounted Payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is 3 years.

Time:	0	1	2	3	4	5
Cash flow:	-1,000	400	580	500	400	250

3.42 years, reject

4.72 years, reject

2.42 years, accept

2.72 years, accept

Answer 1

Year	Cash flows	Present value@10%	Cumulative Cash flows
0	(1000)	(1000)	(1000)
1	400	363.64	(636.36)
2	580	479.34	(157.02)
3	500	375.66	218.64

This would go on upto year 5.

Hence discounted 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+(157.02/375.66)

=2.42 years.(Approx).

Hence since discounted payback is less than 3 years;project must be accepted.(C).