You are analyzing a project and have prepared the following data:
$\begin{array} { | l | l | }
\hline \text { Year } & \text { Cash Flow } \
\hline 0 & £ £ 169,000 \
\hline 1 & £ 46,200 \
\hline 2 & £ 87,300 \
\hline 3 & £ 41,000 \
\hline 4 & £ 39,000 \
\hline
\end{array}$
Required payback period: 2.5 years Required AAR: 7.25% Required return: 8.50% Based on the payback period of _____for this project, you should _____ the project.
A)1.87 years; accept
B)2.87 years; accept
C)2.87 years; reject
D)3.13 years; reject
E)3.87 years; reject

Question

You are analyzing a project and have prepared the following data: 
$\begin{array} { | l | l | } 
\hline \text { Year } & \text { Cash Flow } \
\hline 0 & £ £ 169,000 \
\hline 1 & £ 46,200 \
\hline 2 & £ 87,300 \
\hline 3 & £ 41,000 \
\hline 4 & £ 39,000 \
\hline
\end{array}$
 Required payback period: 2.5 years Required AAR: 7.25% Required return: 8.50% Based on the payback period of _____for this project, you should _____ the project.
A)1.87 years; accept
B)2.87 years; accept
C)2.87 years; reject
D)3.13 years; reject
E)3.87 years; reject

Quizplus · Accepted Answer

To find the payback period, we need to calculate the cumulative cash flows until they exceed the initial investment:
Year 0: £169,000
Year 1: £46,200
Year 2: £87,300
Year 3: £41,000
Year 4: £39,000
Cumulative Cash Flows: Year 0: £169,000 Year 1: £215,200 Year 2: £302,500 Year 3: £343,500 Year 4: £382,500
It takes 2 years and 9 months (or 2.87 years) to exceed the initial investment, which is longer than the required payback period of 2.5 years.
To calculate the AAR, we need to find the average net income over the life of the project and divide it by the initial investment:
Average Net Income = (46,200 + 87,300 + 41,000 + 39,000) / 4 = £53,875
AAR = 53,875 / 169,000 = 0.319
The required AAR is 7.25%, which is lower than the calculated AAR of 31.9%.
Finally, to calculate the NPV, we need to discount each cash flow and sum them:
NPV = -169,000 + 46,200 / (1 + 0.085)^1 + 87,300 / (1 + 0.085)^2 + 41,000 / (1 + 0.085)^3 + 39,000 / (1 + 0.085)^4
NPV = -9,778.09
Since the NPV is negative, the project should be rejected. Therefore, the best choice is C, 2.87 years, reject.

You Are Analyzing a Project and Have Prepared the Following