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 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 3.0 and 3.5 years, respectively. Time: 0 1 2 3 4 5 Cash flow: –$240,000 $66,300 $84,500 $141,500 $122,500 $81,700 Use the payback decision rule to evaluate this project

Answer 1

Project
Year	Cash flow stream	Cumulative cash flow
0	-240000	-240000
1	66300	-173700
2	84500	-89200
3	141500	52300
4	122500	174800
5	81700	256500
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 2 and 3
therefore by interpolation payback period = 2 + (0-(-89200))/(52300-(-89200))
2.63 Years
Accept project as payback period is less than 3 years
Project
Year	Cash flow stream	Cumulative cash flow
0	-240000	-240000
1	66300	-173700
2	84500	-89200
3	141500	52300
4	122500	174800
5	81700	256500
Discounted payback period is the time by which discounted cashflow cover the intial investment outlay
this is happening between year 3 and 4
therefore by interpolation payback period = 3 + (0-(-8224.59))/(72469.95-(-8224.59))
3.1 Years
Where
Discounting factor =(1 + discount rate)^(corresponding year)
Discounted Cashflow=Cash flow stream/discounting factor

accept project as disccounted payback is less than 3.5 years