The cash flows associated with three different projects are as follows: Cash Flo
ID: 2645010 • Letter: T
Question
The cash flows associated with three different projects are as follows:
Cash Flows
Alpha
Beta
Gamma
Initial flow
-1.5
-0.4
-7.5
Yr 1
0.3
0.1
2.0
Yr 2
0.5
0.2
3.0
Yr 3
0.5
0.2
2.0
Yr 4
0.4
0.1
1.5
Yr 5
0.3
-0.2
5.5
A.) Calculate the payback period of each investment. B.) Which investment does the firm accept if the cutoff payback period is three years? Four years? C.) If the firm invests by choosing with the shortest payback period, which project would it invest in? D.) If the firm uses discounted payback with a 15% discount rate and a four-year cutoff period, which projects will it accept?
Cash Flows
Alpha
Beta
Gamma
Initial flow
-1.5
-0.4
-7.5
Yr 1
0.3
0.1
2.0
Yr 2
0.5
0.2
3.0
Yr 3
0.5
0.2
2.0
Yr 4
0.4
0.1
1.5
Yr 5
0.3
-0.2
5.5
Explanation / Answer
a.
Payback = 3 + |-.2|/04 = 3.5 years
Payback = 2 + |-.1|/.2 = 2.5 years
However, notice that the cumulative cashflow again drops to 0 at 5th year. So the actual payback = 5 years
payback = 3 + |-.5|/1.5 = 3.33 years
b. If the cutoff is 3 years, the firm will have to reject all 3.
If the cutoff is 4 years, the firm can accept either of: Alpha or Gamma
c.Gamma, as it has the shortest payback at 3.33 years
d.
as the cumulative cashflows are still negative, there is no payback period
As the last cashflow is negative, there is no payback period
payback = 4 + |-1.31978|/2.734 = 4.48 years
None of the projects have a payback of less than 4 years using the discounted payback method, so all of them will have to be rejected
Cash Flows Alpha Cumulative 0 -1.5 -1.5 1 0.3 -1.2 2 0.5 -0.7 3 0.5 -0.2 4 0.4 0.2 5 0.3 0.5Related Questions
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