Suppose your firm is considering investing in a project with the cash flows show

Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 7 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively. Time: Cash flow 2 4 -$5,000 $1,270 $2,470 $1,670 $1,590 $1,470 $1,270 Use the payback decision rule to evaluate this project. (Round your answer to 2 decimal places.) Payback Should it be accepted or rejected? O Rejected years Accepted

Explanation / Answer

This would go on upto year 6.

Hence 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+(1260/1670)=2.75 years

Hence since payback is less than 3.5 years;the project should be accepted.

Year Cash flow Cumulative cash flow 0 (5000) (5000) 1 1270 (3730) 2 2470 (1260) 3 1670 410

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