Suppose your firm is considering investing in a project with the cash flows show

Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,070 100 500 700 700 300 700 Use the discounted payback decision rule to evaluate this project; should it be accepted or rejected? 2.92 years, accept 2.83 years, accept 3.08 years, reject 3.09 years, reject

Explanation / Answer

Discounted payback period= year up to which discounted cummulative cash flow is negative +(negative cummulative cash flow /discounted cash flow of next period)

              = 3 + (39.94 / 478.11)

              = 3 + .08

              = 3.08 years

since maximum allowable discounted payback period = 3 ,the project should be rejected as its payback period is 3.08 years

year cash flow present value @10% present value of cash flow cummulative cash f,low 0 -1070 1 -1070 -1070 1 100 .90909 90.91 -979.09 2 500 .82645 413.23 -565.86 3 700 .75131 525.92 -39.94 4 700 .68301 478.11 5 300 .62092 186.28 6 700 .56447 395.13

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