Timeline Manufacturing Co. is evaluating two projects. The company uses payback

Question

Timeline Manufacturing Co. is evaluating two projects. The company uses payback criteria of three years or less. Project A has a cost of $715,740, and project B’s cost is $1,201,700. Cash flows from both projects are given in the following table.

Year Project A Project B

1   $86,212 $586,212

2 $313,562 $413,277

3 $427,594 $231,199

4 $285,552

What are their discounted payback periods? (Round answers to 2 decimal places, e.g. 15.25. If discounted payback period exceeds life of the project, enter 0.00 for the answer.)

(1) Discounted payback period of project A = ____________

(2) Discounted payback period of project B + ___________

(3) Which will be accepted with a discount rate of 8 percent? Timeline should choose ____________.

Explanation / Answer

Discounted pay back period is the time by which the investor is getting his investment back after considering time value of money

First calculate PV's of each cash flow using below formula

PV = Cash flow / (1+r)n

All PV's are calculated in below table

(1) Discounted payback of A:

Sum of present values of 3 years cash flow = 688,092.70

Cash flow in year 4 = 209,889.24

So Discounted payback = 3 + (715,740.00 - 688,092.70 ) / 209,889.24 = 3 + 27647.30 / 209,889.24 = 3.13 years

(2) Discounted payback of B:

Sum of present values of 3 years cash flow =  1,080,640.52

Since Sum of present values of 3 years cash flow < initial investment, the investor is not getting his investment on the project. So there is no Discounted payback for this project, however as given in question you have enter Discounted payback as 0.00

(3) Always choose a project with less Discounted payback period, since A has least Discounted payback period one should choose A, however it is given in the question the company uses payback criteria of 3 years or less. Since Discounted payback of A is more than 3, it should not choose A either. So it should not go ahead with either A or B.

So Discounted payback = 3 + (715,740.00 - 688,092.70 ) / 209,889.24 = 3 + 27647.30 / 209,889.24 = 3.13 years

Year Project A Project B PV of A PV of B 0         (715,740.00)          (1,201,700.00)           (715,740.00)     (1,201,700.00) 1              86,212.00                586,212.00                79,825.93           542,788.89 2            313,562.00                413,277.00             268,828.88           354,318.42 3            427,594.00                231,199.00             339,437.90           183,533.22 4            285,552.00             209,889.24

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