Question

Your boss, the chief financial officer (CFO) for Southern Textiles, has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s fabric line. It would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives because Southern is planning to introduce an entirely new fabric at that time.

Here are the net cash flow estimates (in thousands of dollars):

  Expected Net Cash Flows   Year             Project L               Project S

0                   $(100)                 $(100)

1                        10                        70

2                        60                        50

3                        80                        20

The CFO also made subjective risk assessments of each project, and he concluded that the projects both have risk characteristics that are similar to the firm’s average project. Southern’s required rate of return is

10%. You must now determine whether one or both of the projects should be accepted.

(2)    What is the difference between the traditional payback and the discounted payback?

What is each project’s discounted payback?

Answer 1