Sears is considering investing $40,000 in a project that promises $13,000 per ye

Question

Sears is considering investing $40,000 in a project that promises $13,000 per year in after-tax cash inflows for 5 years. If the cost of capital is 16% per year and the company's president requires that all independent projects have a discounted payback period of 4-year or less, should the company invest in this project? What's the project's discounted payback period?

This project has a discounted payback period of 4.57 years. Since this number exceeds the target discounted payback period, the company should not invest.

This project has a discounted payback period of 3.08 years. Since this number is lower than the target discounted payback period, the company should invest.

This project has a discounted payback period of 4.57 years. Since this number exceeds the target discounted payback period, the company should invest.

This project has a discounted payback period of 3.08 years. Since this number is lower than the target discounted payback period, the company should not invest.

1.

This project has a discounted payback period of 4.57 years. Since this number exceeds the target discounted payback period, the company should not invest.

2.

This project has a discounted payback period of 3.08 years. Since this number is lower than the target discounted payback period, the company should invest.

3.

This project has a discounted payback period of 4.57 years. Since this number exceeds the target discounted payback period, the company should invest.

4.

This project has a discounted payback period of 3.08 years. Since this number is lower than the target discounted payback period, the company should not invest.

Explanation / Answer

Discounted Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=4+(3623.54/6189.47)=4.57 years(Approx)

Hence since payback is not less than 4 years;project should not be accepted.(A).

Year Cash flows Present value@16% Cumulative Cash flows 0 (40,000) (40,000) (40,000) 1 13000 11206.90 (28793.10) 2 13000 9661.12 (19131.98) 3 13000 8328.55 (10803.43) 4 13000 7179.78 (3623.65) 5 13000 6189.47 2565.82

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