Question

Tony V’s has invested $6,497,400 on equipment and anticipates cash flows of $1,273,158, $1,536,534, $1,685,265, $2,294,991, $2,449,500, and $2,476,125 over the next six years. Assume that the discount rate is 10 percent. What is the discounted payback period for the project? The firm uses payback period criteria of not accepting any project that takes more than four years and 9 months to recover costs. The company. and should the firm buy the equipment based on the firm's payback criteria?

  

A. 3.87 years, accept

   

B. 3.87 years, reject

   

C. 4.81 years, reject

   

D. Cannot compute discounted payback period

Answer 1

Discounted Cash flow of year 1 =1273158/(1+r) =1273158/(1+10%) =1157416.3636
Discounted Cash flow of year 2 =1536534/(1+r)^2 =1536534/(1+10%)^2 =1269862.8099
Discounted Cash flow of year 3 =1685265/(1+r)^2 =1685265/(1+10%)^2 =1392780.9917
Discounted Cash flow of year 4 =2294991/(1+r)^2 =2294991/(1+10%)^2 =1896686.7769
Discounted Cash flow of year 5 =2449500/(1+r)^2 =24495004/(1+10%)^2 =2024380.1653
Discounted Cash flow of year 6 =2476125/(1+r)^2 =2476125/(1+10%)^2 =2046384.2975

Discounted Payback Period =Years before recovery + Cost not covered in that year/ Cash flow for that year
=4+(6,497,400-1157416.3636-1269862.8099-1392780.9917-1896686.7769)/2024380.1653 =4.39 Years

Payback Period=Years before recovery + Cost not covered in that year/ Cash flow for that year
=3+(6,497,400-127315-153653-1685265)/2294991 =3.87 years
Since Payback Period is less than 4 years and 9 months project should be accepted.

Option a is correct option.