Suppose your firm is considering two mutually exclusive, required projects with

Question

Suppose your firm is considering two mutually exclusive, required projects with the cash fows 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: Project A ash Flow 22,000 32,000 3,000 2,000 Project 8 Cash Flow Use the paybeck decision rule to evaluate these projects; which one(s) should be accepted or rejected? O accept neither A nor B O accept both A and B O reject A, accept B O accept A, reject B

Explanation / Answer

A:

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

=1+(10000/32000)=1.3125 years

B:

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

=2+(2000/52000)=2.038 years

Hence A must be accepted only having payback of less than 2 years.

Year Cash flows Cumulative Cash flows 0 (22000) (22000) 1 12000 (10000) 2 32000 22000 3 3000 25000

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