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 7 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 –$5,300 $1,300 $2,500 $1,700 $1,620 $1,500 $1,300

Answer 1

Year	Cash Flow	Cumulative CFs	Discounted CFs @7%	Cumulative Discounted CFs
0	-5,300	-5,300	-5,300	-5,300
1	1,300	-4,000	1,214.95	-3,785.05
2	2,500	-1,500	2,183.60	-1,601.45
3	1,700	200	1,387.71	- 213.74
4	1,620	1,820	1,235.89	1,022.15
5	1,500	3,320	1,069.48	2,091.63

6 1,300 4,620 866.24 2,957.87

Payback Period = Years before full recovery +

[Unrecovered cost at start of the year / CF during the year]

= 2 + [1,500/1,700] = 2 + 0.88 = 2.88 years

Discounted Payback Period = Years before full recovery + [Unrecovered discounted cost at start of the year / Discounted CF during the year]

= 3 + [213.74/1,235.89] = 3 + 0.17 = 3.17 years