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 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively.

Time	0	1	2	3	4	5	6
Cash Flow	-1,030	130	470	670	670	270	670

Use the payback decision rule to evaluate this project; should it be accepted or rejected?

Answer 1

Cumulative cash flow in year 1= $130

Cumulative cash flow in year 2= $600

Payback period= full years until recovery + unrecovered cost at the start of the year/ cash flow during the year

= 2 years + ($1,030 - $600)/ $670

= 2 years + $430/ $670

= 2 years + 0.64

= 2.64 years.

The project should be rejected since the payback period of the project is more than the maximum allowable discounted payback period of 2 years.

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