Question

Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

Year	Cash Flow A		Cash Flow B
0	–$	64,000	–$	109,000
1		26,500		28,500
2		34,400		33,500
3		28,500		25,500
4		14,500		231,000

Requirement 1:

What is the payback period for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

	Payback period
Project A	years
Project B	years

Requirement 2:

Should it accept either of them?

Answer 1

Payback period of project A is computed as shown below:

Year	Cash Flows	Cumulative Cash Flows
0	- $ 64,000	- $ 64,000
1	$ 26,500	- $ 37,500 ( - $ 64,000 + $ 26,500)
2	$ 34,400	- $ 3,100 ( - $ 37,500 + $ 34,400 )
3	$ 28,500	$ 25,400 ( - $ 3,100 + $ 28,500 )

Payback period is the period in which we are able to recover our initial investment and in this case it lies between year 2 and year 3 and is computed as shown below:

= 2 years + Balance investment to be recovered / Next years cash flows

= 2 years + $ 3,100 / $ 28,500

= 2.11 years Approximately

Payback period of project B is computed as shown below:

Year	Cash Flows	Cumulative Cash Flows
0	- $ 109,000	- $ 109,000
1	$ 28,500	- $ 80,500 ( - $ 109,000 + $ 28,500)
2	$ 33,500	- $ 47,000 ( - $ 80,500 + $ 33,500 )
3	$ 25,500	- $ 21,500 ( - $ 47,000 + $ 25,500 )
4	$ 231,000	$ 209,500 ( - $ 21,500 + $ 231,000)

Payback period is the period in which we are able to recover our initial investment and in this case it lies between year 3 and year 4 and is computed as shown below:

= 3 years + Balance investment to be recovered / Next years cash flows

= 3 years + $ 21,500 / $ 231,000

= 3.09 years Approximately

Since the payback period of project A lies within the cut off of 3 years hence project A should be accepted.

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