The Square Box is considering two independent projects, both of which have an in

Question

The Square Box is considering two independent projects, both of which have an initial cost of $18,000. The cash inflows of Project A are $3,000, $7,000, and $15,000 over the next three years, respectively. The cash inflows for Project B are $5,000, $7.000, and $10,000 over the next three years, respectively. The required return is 12 percent and the required discounted payback period is 3 years. Based on discounted payback, which projectís), if either should be accepted? Project A should be accepted and Project B should be rejected. Both projects should be rejected. You should be indifferent to accepting either or both projects. O Project A should be rejected and Project B should be accepted. Both projects should be accepted.

Explanation / Answer

Project A should be accepted and Project B should be rejected.

Working:

Project A Year Cash flow Discount factor Present Value Cumulative present value 0 $             -18,000              1.0000 $                 -18,000 $           -18,000 1 $                 3,000              0.8929 $                     2,679 $           -15,321 2 $                 7,000              0.7972 $                     5,580 $             -9,741 3 $               15,000              0.7118 $                   10,677 $                  936 Discounted payback is the payback period under which intial cost is recovered back. Under discounted payabck period, time value of cash flow is also considered. Discounted payback = 2+(9741/10677) = 2.91 Years Project B Year Cash flow Discount factor Present Value Cumulative present value 0 $             -18,000              1.0000 $                 -18,000 $           -18,000 1 $                 5,000              0.8929 $                     4,464 $           -13,536 2 $                 7,000              0.7972 $                     5,580 $             -7,955 3 $               10,000              0.7118 $                     7,118 $                 -838 Discounted payback is the payback period under which intial cost is recovered back. Under discounted payabck period, time value of cash flow is also considered. Project B is not paying back during the life of 3 years. Thus, Project A is acceptable on the basis of payback period.

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