Question

Howdy Ltd relies on the payback method of project evaluation, requiring that investments repay capital within three years. The board are currently considering the four projects listed below: (ignore tax)

Project A B C D

$ $ $ $

Sales 40,000 75,000 60,000 60,000

Direct costs 16,000 27,000 15,000 18,000

Depreciation 8,000 40,000 30,000 35,000

Interest 12,000 16,000 9,000 7,000

Initial investment 120,000 160,000 90,000 70,000

Project life (years) 10 10 18 15 The engineering department has requested the board to evaluate these opportunities by means of a discounted cash flow technique. The finance department personnel have been unwilling to use a discounted cash flow technique because of difficulty in establishing an appropriate discount rate. They therefore propose to calculate each project's internal rate of return and let the board determine appropriate hurdle rates. Required: (a) Calculate each project's payback period and state which project (s) should be accepted based on this criterion.

Answer 1