Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.

Time: 0 1 2 3

Project A Cash Flow -39,000 29,000 49,000 20,000

Project B Cash Flow -49,000 29,000 39,000 69,000

Use the discounted payback decision rule to evaluate these projects; which one(s) should it be accepted or rejected?

Multiple Choice

• accept both A and B

• reject A, accept B

• accept neither A nor B

• accept A, reject B

Answer 1

Discounted Payback Period is a method that calculates how long a business will take to recover the initial investment. It is calculated by taking into account the time value of money. It discounts the cash flows.

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

Project A

Discounted payback period = 1 year+ $13,107.14/ $39,200

                                                      = 1 year + 0.3344 =1.33 years

Project B

Discounted payback period = 1 year+ $23,107.14/ $31,200

                                                      = 1 year + 0.74 = 1.74 years.

Both the projects should be accepted since their discounted payback period is lesser than the maximum allowable discounted payback period of 3 years.