1. Suppose your firm is considering two independent projects with the cash flows
ID: 2823997 • Letter: 1
Question
1. Suppose your firm is considering two independent projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 12 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three years, respectively.
Time
0
1
2
3
Project A Cash Flow
?5,000
1,000
3,000
5,000
Project B Cash Flow
?10,000
5,000
5,000
5,000
Use the payback decision rule to evaluate these projects; which one(s) should be accepted or rejected?
A. ACCEPT BOTH A AND B
B. ACCEPT NEITHER A NOR B
C. ACCEPT A, REJECT B
D. REJECT A, ACCEPT B
Time
0
1
2
3
Project A Cash Flow
?5,000
1,000
3,000
5,000
Project B Cash Flow
?10,000
5,000
5,000
5,000
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).
=2+(1000/5000)
=2.2 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 years.
Hence since projects are independent;both the projects must be accepted having payback lower than 2.5 years.(A).
Year Cash flows Cumulative Cash flows 0 (5000) (5000) 1 1000 (4000) 2 3000 (1000) 3 5000 4000Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.