12. Suppose your firm is considering two mutually exclusive, required projects w

Question

12. Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 10 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time: 0 1 2 3 Project A Cash Flow -37,000 27,000 47,000 18,000 Project B Cash Flow -47,000 27,000 3,000 67,000 Use the payback decision rule to evaluate these projects; which one(s) should it be accepted or rejected? Please clearly show all steps either written out step by step or in a chart that is clearly understood.

Explanation / Answer

All Amounts in $ Let us evaluate each project separately based on the Payback period concept Project A Outflow = 37000 Inflows Year 1 27000 1 year Year 2 10000 2.553191 months Total Payback Period = 1 year 3 months (rounded off) Project B Outflow = 47000 Inflows Year 1 27000 1 year Year 2 3000 2 years Year 3 17000 3.044776 months Total Payback Period = 2 year 3 months (rounded off) Since the payback period for Project A is smaller, hence the same should be accepted.

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