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 9 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 –$5,200 $1,250 $2,450 $1,650 $1,570 $1,450 $1,250 Use the payback decision rule to evaluate this project. (Round your answer to 2 decimal places.) Payback years Should it be accepted or rejected? Accepted Rejected

Answer 1

Simple Payback Period

Year	Cash Flows	Cumulative net Cash flow
0	-5,200	-5,200
1	1,250	-3,950
2	2,450	-1,500
3	1,650	150
4	1,570	1,720
5	1,450	3,170
6	1,250	4,420

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

= 2 Year + ($1,500 / 1,650)

= 2 Year + 0.909 years

= 2.909 Years

Discounted Payback Period

Year	Cash Flows	PVF at 9%	Discounted Cash Flow	Cumulative net discounted Cash flow
0	-5,200	1.0000	-5,200.00	-5,200.00
1	1,250	0.91743	1,146.79	-4,053.21
2	2,450	0.84167	2,062.12	-1,991.09
3	1,650	0.77218	1,274.10	-716.99
4	1,570	0.70842	1,112.23	395.24
5	1,450	0.64993	942.40	1,337.64
6	1,250	0.59626	745.33	2,082.97

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

= 3 Year + ($716.99 / $1112.23)

= 3 Year + 0.645 years

= 3.645 years

DICISION

YES. The Project should be accepted, since the Actual Payback period computed is less than the required payback period under both simple and discounted payback period methods