8. Suppose your firm is considering two mutually exclusive, required projects wi
ID: 1175707 • Letter: 8
Question
8. Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively. Calculate the payback and use the payback decision rule to evaluate these projects; which one(s) should be accepted or rejected and why?
Time 0 1 2 3
Project A Cash Flow -1000 300 400 700
Project B Cash Flow -500 200 400 300
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+(300/700)
=2.43 years(Approx)
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).
=1+(300/400)
=1.75 years
Hence B must be accepted and A rejected having lower payback period.(since projects are mutually exclusive;only project having lower payback period must be accepted).
Year Cash flows Cumulative Cash flows 0 (1000) (1000) 1 300 (700) 2 400 (300) 3 700 400Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.