Question

Compute the 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 12 percent and the maximum allowable payback is 4 years.

Time:	0	1	2	3	4	5
Cash flow:	-3,100	950	700	850	725	625

Multiple Choice

• 3.83 years, Reject

• 2.83 years, Accept

• 2.83 years, Reject

• 3.83 years, Accept

Answer 1

Ans:

Payback period = A + ((C-B)/C)
A = year before where cash flow become positive
B = cummulative amount in the year where amount become positive
C = total amount of cash flow in the year where amount become positive

Year	Cash flows	Cummulative cash flows
0	-3100	-3100
1	950	-2150
2	700	-1450
3	850	-600
4	725	125
5	625	750

Payback period = 3 years + ((725-125/725)

= 3 + (600/725)

= 3.8275 years

= 3.83 years

since payback period is less than 4 years. it is acceptable.

Option D 3.83 years , Accept.