Global Toys, Inc., imposes a payback cutoff of three years for its international

Question

Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available. Year Cash Flow A Cash Flow B 0 –$ 53,000 –$ 98,000 1 21,000 23,000 2 27,800 28,000 3 23,000 31,000 4 9,000 242,000 Requirement 1: What is the payback period for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).) Payback period Project A years Project B years Requirement 2: Should it accept either of them?

Explanation / Answer

Project A Pay back period Initial Outlay -53000 -53000 Year 1 21000 -32000 Year 2 27800 -4200 Year 3 23000 18800 Year 4 9000 27800 From the above it is clear that the pay back period falls between Year 2 & 3 . If cash flow is assumed even in every month of year 3 , then monthly cash flow = 23000/12 = 1917 per month Hence number of months required to get back 4200 is 4200/1917 = 2 months (approx) Hence payback period for Project A is 2 years and 2 months Project B Pay back period Initial Outlay -98000 -98000 Year 1 23000 -75000 Year 2 28000 -47000 Year 3 31000 -16000 Year 4 242000 226000 From the above it is clear that the pay back period falls between Year 3 & 4 . If cash flow is assumed even in every month of year 4 , then monthly cash flow = 242000/12 = 20167 1917 per month Hence number of months required to get back 16000 is 16000/20167 = 1 month (approx) Hence payback period for Project B is 3 years and 1 month Yes, the company should accept Project A , as the payback period is lower and it falls within the cut off period of 3 years

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