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 2.0 and 3.0 years, respectively. Time: 0 1 2 3 4 5 6 Cash flow –$4,500 $1,110 $2,310 $1,510 $1,510 $1,310 $1,110 Use the discounted payback decision rule to evaluate this project. (Round your answer to 2 decimal places.) Discounted payback years Should it be accepted or rejected? Accepted Rejected

Explanation / Answer

This would go on upto year 6.

Hence discounted Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=3+(212.37/1151.97)

=3.18 years(Approx)

Hence since discounted payback is greater than 3 years,the project should be rejected.

Year Cash flow Present value@7% Cumulative Cash flows 0 (4500) (4500) (4500) 1 1110 1037.38 (3462.62) 2 2310 2017.64 (1444.98) 3 1510 1232.61 (212.37) 4 1510 1151.97 939.60

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