Question

Consider an investment of $150,000 that will generate the following cash flows:

Year1: $20,000

Year 2: $35,000

Year 3: $60,000

Year 4: $75,000

Year 5: $45,000.

The firm’s cost of capital is 8% and it requires a discounted payback period of 4.1 years. What is the discounted payback of this investment opportunity, and will the firm accept or reject it?

		C. 3.9 years - Reject
		B. 4.0 years - Reject
		A. 4.0 years - Accept
		D. 3.9 years - Accept

Answer 1

Year	Cash flows	Present value@8%	Cumulative Cash flows
0	(150,000)	(150,000)	(150,000)
1	20,000	18518.52	(131481.48)
2	35000	30006.86	(101474.62)
3	60,000	47629.93	(53844.69)
4	75000	55127.24	1282.55
5	45000	30626.24	31908.79

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).

=3+(53844.69/55127.24)

=4 years(Approx)

Hence since discounted payback is less than 4.1 years;project must be accepted.

Hence the correct option is:

4 years-Accept