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.

What is the payback period for each project?

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 -$59,000 -$104,000 1 $24,000 $26,000 2 $31,400 $31,000 3 $26,000 $28,000 4 $12,000 $236,000 Requirement 1:

What is the payback period for each project?

Requirement 2: Should it accept either of them?

Explanation / Answer

1) Payback period of a project is found by counting the number of years it takes before the cumulative forecasted cash flow equals the initial investment.
1) Payback period of Project A :
24000+31400+x = 59000

=> x= 3600 $

Since year 3 earning is 26000$ , it will take 3600/26000=0.139 years to earn 3600$.

Total years reqired = 2+0.139 = 2.139 years Payback period
   Payback period of Project B :
26000+31000+28000+x = 104,000
=> x= 19000 $

Since year 3 earning is 236,000$ , it will take 19000/236,000=0.080 years to earn 19000$.

So, Total years required for payback = 3+0.080 = 3.080 Years

2) Even though the NPV of project B is higher on any rate>0% ,on the basis of cutoff payback period is 3 years , we should accept Project A.

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