Suzaki Manufacturing Company is considering three new projects, each requiring a

Question

Suzaki Manufacturing Company is considering three new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following cash inflows. The equipment's salvage value is zero. Suzaki uses straight-line depreciation. Suzaki will not accept any project with a payback period over 2 years. Suzaki's minimum required rate of return is 12%. Instructions Compute each project's payback period, indicating the most desirable project and the least desirable project using this method. (Round answers to 2 decimal places, e.g. 10.50.)

Explanation / Answer

The question has asked for the payback period and not the discounted payback period. So, we would be calculating payback period.

Payback period is th eperiod in which the project's initial cash outflows get recovered.

Where,

In the above formula,
A is the last period with a negative cumulative cash flow;
B is the absolute value of cumulative cash flow at the end of the period A;
C is the total cash flow during the period after A

So, payback period = 2 + |-6,000| / 15,000 = 2.40 Years. So, this is not acceptable.

Payback period = 2 + |-3,000| / 9,500 = 2.32 Years. So, this is also not acceptable.

Payback period = 1 + |-9,000| / 10,000 = 1.90 Years. So, this is within 2 years and so it is acceptable. So, payback project CC with payback period of 1.90 Years is the correct option.

If discounted payback period is required, use the same formula on the discounted cash flows in place of gross cash flows.

Payback Period = A + B C

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