Question

1. Consider the following three-year project. The initial after-tax outlay or after-tax cost is $1,500,000. The future after-tax cash inflows for years 1, 2, 3 and 4 are: $800,000, $800,000, $300,000 and $100,000, respectively. What is the payback period without discounting cash flows?

a. 1.875 years

b. 2.0 years

c. 3.5 years

d. 4.125 years

2. Carvic, Inc. is considering a four-year project that has an initial outlay or cost of $100,000. The respective future cash inflows from its project for years 1, 2, 3 and 4 are: $50,000, $40,000, $30,000 and $20,000. Will it accept the project if it's payback period is 26 months?

a. No, because it pays back in over 31 months

b. No, because it pays back in 28 months

c. No, because it pays back in over 35 months

d. Yes, because it pays back in 25 months

Answer 1

1.

Year	Cash flows	Cumulative Cash flows
0	(1,500,000)	(1,500,000)
1	800,000	(700,000)
2	800,000	100,000
3	300,000	400,000
4	100,000	500,000

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+(700,000/800,000)

=1.875 years

2.

Year	Cash flows	Cumulative Cash flows
0	(100,000)	(100,000)
1	50000	(50000)
2	40000	(10000)
3	30000	20000
4	20000	40000

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+(10000/30000)

=2.33 years

=2.33 years*12

=28 months

Hence since payback period is only 26 months;project must not be accepted(Option B).