Question

Offshore Drilling Products, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

Year	Cash Flow A		Cash Flow B
0	–$	49,000	–$	94,000
1		19,000		21,000
2		25,400		26,000
3		21,000		33,000
4		7,000		246,000

Requirement 1:

What is the payback period for each project? (Enter rounded answers as directed, but do not use the rounded numbers in intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

	Payback period
Project A	_______________years
Project B	________________years

Answer 1

Project A:

Cumulative cash flow for year 0 = -49,000

Cumulative cash flow for year 1 = -49,000 + 19,000 = -30,000

Cumulative cash flow for year 2 = -30,000 + 25,400 = -4,600

cumulative cash flow for year 3 = -4,600 + 21,000 = 16,400

4,600 / 21,000 = 0.219

Payback period = 2 + 0.219 = 2.22 years

Project B:

Cumulative cash flow for year 0 = -94,000

Cumulative cash flow for year 1 = -94,000 + 21,000 = -73,000

Cumulative cash flow for year 2 = -73,000 + 26,000 = -47,000

cumulative cash flow for year 3 = -47,000 + 33,000 = -14,000

cumulative cash flow for year 4 = -14,000 + 246,000 = 232,000

14,000 / 246,000 = 0.0569

Payback period = 3 + 0.0569 = 3.06 years