The Square Box is considering two projects, both of which have an initial cost o

Question

The Square Box is considering two projects, both of which have an initial cost of $35,000 and total cash inflows of $50,000. The cash inflows of project A are $5,000, $10,000, $15,000, and $20,000 over the next four years, respectively. The cash inflows for project B are $20,000, $15,000, $10,000, and $5,000 over the next four years, respectively. Which one of the following statements is correct if The Square Box requires a 13 percent rate of return and has a required discounted payback period of 3.5 years?

Explanation / Answer

Proj A : Kd=13%

Disc CF for Proj A = Y1/(1+Kd)^1 + Y2/(1+Kd)^2 + Y3/(1+Kd)^3 +Y4/(1+Kd)^4

ie DCF Proj A= 5000/(1+13%)^1 + 10000/(1+13%)^2 + 15000/(1+13%)^3 + 20000/(1+13%)^4 = $34,918

As DCF for Proj A is less than Initial Inv 35000, Its DPBP is more than 3.5 Yrs

DCF Proj B= 20000/(1+13%)^1 + 15000/(1+13%)^2 =$29,446

DCF Y3 = 10000/(1+13%)^3 = 6931

DO DPBP = 2+(35000-29446)/6931 = 2.80 Yrs

So Proj B should be accepted as its Disc PBP is less than 3.5 Yrs

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