Question

An investment project requires a net investment of $100,000. The project is expected to generate annual net cash inflows of $28,000 for the next 5 years. The firm's cost of capital is 12 percent. Determine whether you would accept or reject the project using the discounted payback period method. The company rejects projects that exceed a discounted payback period of over 3 years.

       4.94 years, Reject the project
       2.5 years, accept
       4.09 years, accept
       1.43 years, accept
       You cannot calculate discounted payback from the information given.

Answer 1

Year	Cash flows	Present value@12%	Cumulative Cash flows
0	(100,000)	(100,000)	(100,000)
1	28000	25000	(75000)
2	28000	22321.43	(52678.57)
3	28000	19929.85	(32748.72)
4	28000	17794.51	(14954.21)
5	28000	15887.95	933.74(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).

=4+(14954.21/15887.95)

=4.94 years

Hence since discounted payback is greater than 3 years;project must be rejected.