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 9 percent, and that the maximum allowable payback and discounted payback statistics for the project are 2.5 and 3.5 years, respectively. Time Cash flow -$4,900 $1,190 $2,390 $1,590 $1,590 $1,390 $1,190 Use the payback decision rule to evaluate this project. (Round your answer to 2 decimal places.) Payback years Should it be accepted or rejected? ORejected OAccepted

Explanation / Answer

This would continue upto year 6.

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

2+(1320/1590)

which is equal to

=2.83 years(Approx)

Hence since payback is greater than 2.5 years;the project should be rejected.

Year Cash flows Cumulative Cash flows 0 (4900) (4900) 1 1190 (3710) 2 2390 (1320) 3 1590 270

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