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 8 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: −$5,000 $1,200 $2,400 $1,600 $1,600 $1,400 $1,200 Use the payback decision rule to evaluate this project. (Round your answer to 2 decimal places.)

Compute the payback statistic for Project A if the appropriate cost of capital is 9 percent and the maximum allowable payback period is four years. (Round your answer to 2 decimal places.) Project A Time: 0 1 2 3 4 5 Cash flow: –$2,400 $910 $900 $800 $580 $380

Answer 1

Payback Period for the Project

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	-5,000	-5,000
1	1,200	-3,800
2	2,400	-1,400
3	1,600	200
4	1,600	1,800
5	1,400	3,200
6	1,200	4,400

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Year + ($1,400 / $1,600)

= 2.00 Year + 0.88 years

= 2.88 Years

“Hence, the Payback Period for the Project will be 2.88 Years”

DECISION

-Using the payback decision rule, the Project should be accepted only if the Payback Period for the Project is less than the maximum allowable payback period, else reject the project.

-Here, the Payback Period for the Project (2.88 Years) is lower than the maximum allowable payback period of 3.50 Years. Therefore, the firm should accept the Project.