Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively. $$\begin{array} { | l | c | c | c | c | c | c | }
\hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 \
\hline \text { Cash Flow } & - 100,000 & 30,000 & 45,000 & 55,000 & 30,000 & 10,000 \
\hline
\end{array}$$
A)1.23 years, Accept
B)2.45 years, accept
C)2.77 years, accept
D)5.36 years, reject

Question

Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the project are three and three and a half years, respectively. $$\begin{array} { | l | c | c | c | c | c | c | } 
\hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 \
\hline \text { Cash Flow } & - 100,000 & 30,000 & 45,000 & 55,000 & 30,000 & 10,000 \
\hline
\end{array}$$
A)1.23 years, Accept
B)2.45 years, accept
C)2.77 years, accept
D)5.36 years, reject

Quizplus · Accepted Answer

First, let's calculate the payback period:

Year 1: -$100,000 + $30,000 = -$70,000 remaining
Year 2: -$70,000 + $45,000 = -$25,000 remaining
Year 3: -$25,000 + $55,000 = $30,000 remaining

The payback period is 3 years, which meets the maximum allowable payback requirement.

Next, let's calculate the discounted payback period using a discount rate of 8%:

Year 1: -$100,000 + $30,000/(1+0.08) = -$83,333.33 remaining
Year 2: -$83,333.33 + $45,000/(1+0.08)^2 = -$44,791.41 remaining
Year 3: -$44,791.41 + $55,000/(1+0.08)^3 = $8,711.85 remaining
Year 4: $8,711.85 + $30,000/(1+0.08)^4 = $27,704.32 remaining
Year 5: $27,704.32 + $10,000/(1+0.08)^5 = $31,509.58 remaining

The discounted payback period is between 3 and 4 years, which meets the maximum allowable discounted payback requirement.

Therefore, option C with a payback period of 2.77 years and discounted payback period of 3.64 years is the best choice as it meets both criteria.

Suppose Your Firm Is Considering Investing in a Project with the Cash