Question

A certain project with the following cash flows has been proposed. The board uses the Payback method and will approve only projects that pay back within 3.5 years. Use a discount rate of 8%. Year 0 Investment 650,000 Year 1 Income 305,000 Year 2 Income 295,000 Year 3 Income 125,000 Year 4 Income 117,333 When will the project pay back (number of years)? ___________ Is this a Go or a No Go? ____________ When will the project pay back using Discounted Payback? _______ Is it a Go or a No Go? ____________

Answer 1

1.Cumulative cash flow in year 1= $305,000

Cumulative cash flow in year 2= $600,000

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

= 2 years + ($650,000 - $600,000/ $125,000

= 2 years + $50,000/ $125,000

      = 2 years + 0.40

= 2.40 years.

The project is a Go since the payback period of the project is less than the cut-off payback period of 3.5 years.

2.Cumulative discounted cash flow in year 1= $282,407.41

Cumulative discounted cash flow in year 2= $252,914.95

Cumulative discounted cash flow in year 3= $99,229.98

Cumulative discounted cash flow in year 4= $86,242.56

Discounted payback period= full years until recovery + unrecovered cost at the start of the year/ discounted cash flow during the year

= 3 years + ($650,000 - $634,552.34)/ $86,242.56

= 3 years + $15,447.66/ $86,242.56

= 3 years + 0.18

= 3.18 years.

The project is a Go since the discounted payback period of the project is less than the cut-off payback period of 3.5 years.