Question

Marian Ltd is considering two mutually - exclusive projects with the following details:

Project A

Initial investment Le 450,000

Scrape value in year 5   Le 20,000

Year 1 2 3 4 5

( Le000) ( Le000 ) (Le000) (Le000) ( Le000)

Annual Cash flows 200 150 100 100 100

Project B:

Initial investment Le 100,000

Scrape value in year 5 Le10,000

Year 1 2 3 4 5

( Le000 ) ( Le000 ) ( Le000) ( Le000) ( Le000 )

Annual Cash flows 50 40 30 20 20

Assuming that the initial investment is at the start of the project and the annual cash flows accrue evenly over the year. Calculate the discounted payback for both projects if the relevant cost of capital is 10%.

Answer 1

Based on the given data, pls find below steps, workings and answers:

Computation of Pay Back Period: Here, the period is computed for each project, based on cumulative discounted cash flows: If the cumulative value is less than or equal to zero, the period is considered as 12 months (it means that the net cumulative cash flow has not yet paid back the initial investment); Once the value turns positive in a particular year, the period for such year is observed at a proportion of actual discounted cash flow to the cumulative CF; This gives the period less than 12 months in such year; Once this is computed, total of all the years is taken and divided by 12, to arrive at the Payback period in no.of years.

Answer: The Discounted Payback period for

Project A = 48.2 months or 4.01 Years

Project B = 35.4 months or 2.95 Years

The Project with lower payback period is more recommended over the higher one;