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 11 percent, and that the maximumallowable payback and discounted payback statistics for yourcompany are 3.0 and 3.5 years, respectively. Time: 0 1 2 3 4 5 Cashflow: –$240,000 $66,300 $84,500 $141,500 $122,500 $81,700 Use thepayback decision rule to evaluate this project

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4.4 Ratings (741 Votes)

Project
Year	Cash flow stream	Cumulative cash flow
0	-240000	-240000
1	66300	-173700
2	84500	-89200
3	141500	52300
4	122500	174800
5	81700	256500

Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 2 and 3
therefore by interpolation payback period = 2 + (0-(-89200))/(52300-(-89200))
2.63 Years
Accept project as payback period is less than 3 years



Project
Year	Cash flow stream	Cumulative cash flow
0	-240000	-240000
1	66300	-173700
2	84500	-89200
3	141500	52300
4	122500	174800
5	81700	256500
Discounted payback period is the time by which discounted cashflow cover the intial investment outlay
this is happening between year 3 and 4
therefore by interpolation payback period = 3 + (0-(-8224.59))/(72469.95-(-8224.59))
3.1 Years

Where
Discounting factor =(1 + discount rate)^(corresponding year)
Discounted Cashflow=Cash flow stream/discounting factor

accept project as disccounted payback is less than 3.5 years

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