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Suppose your firm is considering investing in a project with the cash flows shown below, that...

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Finance

Suppose your firm is considering investing in a project with thecash flows shown below, that the required rate of return onprojects of this risk class is 8 percent, and that the maximumallowable payback and discounted payback statistics for the projectare 3.5 and 4.5 years, respectively.

Time:0123456
Cash flow:?$5,000$1,200$2,400$1,600$1,600$1,400$1,200

Use the payback decision rule to evaluate this project.(Round your answer to 2 decimal places.)

Payback _______ years

Should it be accepted or rejected?

Answer & Explanation Solved by verified expert
3.9 Ratings (379 Votes)

To calculate the payback period, we need to calculate the cumulative cash flows

Payback period is the period when the cumulative cash flow becomes positive

Time Cash Flow Cumulative Cash Flow
0 -5000 -5000
1 1200 -3800
2 2400 -1400
3 1600 200
4 1600 1800
5 1400 3200
6 1200 4400

Hence, Payback period = 2 + 1400/1600 = 2.875 years

To calculate the discounted payback period, we need to find the discounted cumulative cash flow

Discounted cash flow = Cash Flow / (1 + discount Rate)year

Time Cash Flow Discounted Cash Flow Cumulative Cash Flow
0 -5000 -5000 -5000
1 1200 1111.111111 -3888.8889
2 2400 2057.613169 -1831.2757
3 1600 1270.131586 -561.14413
4 1600 1176.047764 614.90363
5 1400 952.8164758 1567.72011
6 1200 756.2035523 2323.92366

Discounted Payback period = 3 + 561.14/1176.05 = 3.477 years

Since, both the payback period and discounted payback period is within the maximum allowable threshold, the project should be accepted
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