Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent and the maximum allowable payback is four years. $$\begin{array} { l l l l l l l }
\text { Time: } & 0 & 1 & 2 & 3 & 4 & 5 \
\text { Cash flow: } & - 1000 & - 75 & 100 & 100 & 0 & 2000
\end{array}$$
A)3.4375 years, accept
B)3.78 years, reject
C)4.4375 years, reject
D)4.78 years, accept

Question

Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent and the maximum allowable payback is four years. $$\begin{array} { l l l l l l l } 
\text { Time: } & 0 & 1 & 2 & 3 & 4 & 5 \
\text { Cash flow: } & - 1000 & - 75 & 100 & 100 & 0 & 2000
\end{array}$$
A)3.4375 years, accept
B)3.78 years, reject
C)4.4375 years, reject
D)4.78 years, accept

Quizplus · Accepted Answer

To calculate the payback statistic, we need to keep adding up the cash inflows until we reach the initial investment of $1000.

Year 0: - $1000
Year 1: - $75 (remaining investment: $925)
Year 2: + $100 (remaining investment: $825)
Year 3: + $100 (remaining investment: $725)
Year 4: + $0 (remaining investment: $725)
Payback year: Year 3 + ($725/$100) = Year 4.25

The payback period is 4.25 years, which is above the maximum allowable payback of four years. Therefore, the project should be rejected.

The correct answer is C) 4.4375 years, reject.