Payback period. Given the cash flow of two projects-A and B-and using the paybac

Question

Payback period. Given the cash flow of two projects-A and B-and using the payback period decision model, which projectfs) do you accept and which project(s) do you reject if you have a 3-year cutoff period for recapturing the initial cash outflow? For payback period calculations, assume that the cash flow is equally distributed over the year Cost Cash flow year 1 Cash flow year 2 Cash flow year 3 Cash flow year 4 Cash flow year 5 Cash flow year 6 $12,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 S105,000 $10,500 $21,000 $31,500 $42,000 $0 $0 What is the payback period for project A? years (Round to one decimal place.)

Explanation / Answer

Payback period for A=Initial cash outflow/Annual cash flows

=(12000/6000)=2 years

B:

Hence Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

3+(42000/42000)=4 years.

Hence only project A must be selected having payback lower than 3 year.

Year Cash flows Cumulative Cash flows 0 (105000) (105000) 1 10500 (94500) 2 21000 (73500) 3 31500 (42000) 4 42000 0

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