Question

Compute the Discounted Payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 14 percent and the maximum allowable discounted payback is 3 years.

Time:	0	1	2	3	4	5
Cash flow:	-960	460	520	440	340	190

Compute the PI statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 11 percent.

Time:	0	1	2	3	4	5
Cash flow:	-83	-83	0	108	83	58

Answer 1

First:

Year	Investment	Net annual cash flow	Cumulative net cash flow	Balance to be recovered
0	(960)		-	960.00
1		460	460	500.00
2		520	980	-
3		440	1,420	-
4		340	1,760	-
5		190	1,950	-
Capital is recovered fully in year	2
Pay back period is=	1 + 500/520		1.96

Accept as payback is less than 3 years

Second:

Year	Cash flow	× factor@ 11.00%	Present value
0	$              (83.00)	1.0000	$                    (83.00)
1	$              (83.00)	0.9009	$                    (74.77)
2	$             108.00	0.8116	$                     87.66
3	$                      -	0.7312	$                            -
4	$               83.00	0.6587	$                     54.67
5	$               58.00	0.5935	$                     34.42
NPV		3.6959	$                     18.98

PI = (87.66+54.67+34.42)/(83+74.77) = 1.12

Accept project