Question

Davis Corporation is faced with two independent investment opportunities. The corporation has an investment policy that requires acceptable projects to recover all costs within 3 years. The corporation uses the discounted payback method to assess potential projects and utilizes a discount rate of 10 percent. The cash flows for the two projects are: (Year; Project A; Project B) (0 ; -100,000 ; -80,000) (1 ; 40,000 ; 50,000) (2 ; 40,000 ; 20,000) (3 ; 40,000 ; 30,000) (4 ; 30,000 ; 0) In which investment project(s) should the company invest?

(MANUAL ANSWERS PLS )

Answer 1

Answer : Calculation of Discounted Payback Period :

For Project A ,

Below is the table showing Discounted Payback Period :

Year	Cash Flows	PVF @ 10%	Present value of Cash FlowsCash Flows	Cumulative Cash Flows
1	40000	0.909090909	36363.63636	36363.63636
2	40000	0.826446281	33057.85124	69421.4876
3	40000	0.751314801	30052.59204	99474.07964
4	30000	0.683013455	20490.40366	119964.4833

Investment Value = 100000

Discounted Payback Period = Complete Years + Remaining Cash flow / Cashflow for the year to be recovered

= 3 years + (100,000 - 99474.07964) / 20490.40366

= 3.025667 years or 3.03 years

For Project B ,

Below is the table showing Discounted Payback Period

Year	Cash Flows	PVF @ 10%	Present value of Cash FlowsCash Flows	Cumulative Cash Flows
1	50000	0.909090909	45454.54545	45454.54545
2	20000	0.826446281	16528.92562	61983.47107
3	30000	0.751314801	22539.44403	84522.9151

Investment Value = 80000

Discounted Payback Period = Complete Years + Remaining Cash flow / Cashflow for the year to be recovered

= 2 years + (80,000 - 61983.47107) / 22539.44403

= 2 .80 years

The Corporation Should Accept Project B as it has an investment policy that requires acceptable projects to recover all costs within 3 years and its payback period is less than 3 years.