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 9 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: –$5,200 $1,250 $2,450 $1,650 $1,650 $1,450 $1,250 Use the discounted payback decision rule to evaluate this project. (Round your answer to 2 decimal places.)

Answer 1

Present value of year 1 cash flow = 1250 / (1 + 0.09) = 1,146.78899

Present value of year 2 cash flow = 2,450 / (1 + 0.09)² = 2,062.11598

Present value of year 3 cash flow = 1,650 / (1 + 0.09)³ = 1,274.10274

Present value of year 4 cash flow = 1,650 / (1 + 0.09)⁴ = 1,168.9016

Present value of year 5 cash flow = 1,450 / (1 + 0.09)⁵ = 942.4005

Present value of year 6 cash flow = 1,250 / (1 + 0.09)⁶ = 745.33416

Cumulative cash flow for year 0 = -5200

Cumulative cash flow for year 1 = -5200 + 1,146.78899 = -4,053.21101

Cumulative cash flow for year 2 = -4,053.21101 + 2,062.11598 = -1,991.09503

Cumulative cash flow for year 3 = -1,991.09503 + 1,274.10274 = -716.99229

Cumulative cash flow for year 4 = -716.99229 + 1,168.9016 = 451.91

716.99229 / 1,168.9016 = 0.61

Discounted payback = 3 + 0.61 = 3.61 years