Question

1. Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.

Time |
0 |
1 |
2 |
3 |

Project A Cash Flow |
?1,000 |
300 |
400 |
700 |

Project B Cash Flow |
?500 |
200 |
400 |
300 |

Use the discounted payback decision rule to evaluate these projects; which one(s) should be accepted or rejected?

Answer #1

A:

Year | Cash flows | Present value@10% | Cumulative Cash flows |

0 | (1000) | (1000) | (1000) |

1 | 300 | 272.73 | (727.27) |

2 | 400 | 330.58 | (396.69) |

3 | 700 | 525.92 | 129.23(Approx). |

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+(396.69/525.92)

=2.75 years(Approx).

B:

Year | Cash flows | Present value@10% | Cumulative Cash flows |

0 | (500) | (500) | (500) |

1 | 200 | 181.82 | (318.18) |

2 | 400 | 330.58 | 12.40 |

3 | 300 | 225.39 | 237.79(Approx). |

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).

1+(318.18/330.58)

=1.96 years(Approx).

Hence since projects are mutually exclusive,**B must be
selected only** having lower discounted payback period.

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Suppose your firm is considering two mutually exclusive, required
projects with the cash flows shown as follows. The required rate of
return on projects of both of their risk class is 10 percent, and
the maximum allowable payback and discounted payback statistic for
the projects are two and a half and three and a half years,
respectively.
Time
0
1
2
3
Project A Cash Flow
?1,000
300
400
700
Project B Cash Flow
?500
200
400
300
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Suppose your firm is considering two mutually exclusive, required
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return on projects of both of their risk class is 10 percent, and
the maximum allowable payback and discounted payback statistic for
the projects are two and a half and three and a half years,
respectively.
Time
0
1
2
3
Project A Cash Flow
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300
400
700
Project B Cash Flow
?500
200
400
300
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