Question

In: Finance

Suppose your firm is considering investing in a project with the cash flows shown below, that...

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 7 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: −$5,100 $1,240 $2,440 $1,640 $1,560 $1,440 $1,240

Use the payback decision rule to evaluate this project.

How many years will it take?

Solutions

Expert Solution

Time Cash flows Discount factor at 7% Discounted cash flow Cumulative cash flow Discounted cumulative cash flow
0 -5100 1 -5100.00 -5100.00 -5100.00
1 1240                     0.9346 1158.88 -3860.00 -3941.12
2 2440                     0.8734 2131.19 -1420.00 -1809.93
3 1640                     0.8163 1338.73 220.00 -471.20
4 1560                     0.7629 1190.12 1780.00 718.91
5 1440                     0.7130 1026.70 3220.00 1745.61
6 1240                     0.6663 826.26 4460.00 2571.88
Payback =                          2.87 years
Discounted Payback =                          3.40 years

From the above table we can see that payback period is less than 3.5 years and discounted payback period is less than 4.5 years. Therefore, as per the payback decision rule this project can be accepted.

Formulas used in the above table:

Where,
PB = Payback period

Where,
DPB = Discounted payback period

Excel formulas used:


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