Question

Cas a llars) a. What is the payback period on each of the projects? b. If you use the payback rule with a cutoff period of 2 years, which projects will you accept? e. If you use a cutoff period of 3 years, which projects will you accept? d-1. If the opportunity cost of capital is 10%, calculate the NPV for projects A. B. and C. (Negative amounts should be indicated by a minus sign. Do not round Intermediate calculations, Round your answers to 2 decimal places) d-2. Which projects have positive NPV? e. "Payback gives too much weight to cash flows that occur after the cutoff date." True or false? Project Project Project a Payback period b. you use the payback t h a cu riod of 2 years which project will you accept? you use cutoffered of years with project will you accept? d-1. the opportunity cost of als 10 a NPV for projects A B and C 2. Which prins have positive NPV e Payback h ome who cash fows that occurr the cutoff dute True or is?

Answer 1

Part a)

Project A: Payback period:

Year	Opening Balance	Investment	CF	Closing Balance
0		$            5,400.00		$            5,400.00
1	$              5,400.00		$                      1,100.00	$            4,300.00
2	$              4,300.00		$                      1,100.00	$            3,200.00
3	$              3,200.00		$                      3,200.00	$                         -

• Opening balance = previous years closing balance
• Closing balance = Opening balance+Investment-CF
• We see that the Entire investment is recvered in 3 years time so that is the payback period

Project B: Payback period:

Year	Opening Balance	Investment	CF	Closing Balance
0		$            1,400.00		$            1,400.00
1	$              1,400.00		$                                   -	$            1,400.00
2	$              1,400.00		$                      1,400.00	$                         -

• We see that the Entire investment is recovered in 2 years time so that is the payback period

Project C: Payback period:

Year	Opening Balance	Investment	Principal repayment	Closing Balance
0		$            5,400.00		$            5,400.00
1	$              5,400.00		$                      1,100.00	$            4,300.00
2	$              4,300.00		$                      1,100.00	$            3,200.00
3	$              3,200.00		$                      3,200.00	$                         -

We see that the Entire investment is recovered in 3 years time so that is the payback period

Part b) If cutoff is 2 years then only project 2 is acceptable

Part c) If the cutoff is 3 years then all 3 meet the criteria and can be selected, If they are mutually exclusive and therefore only one can be selected then that will be project B otherwise all can be selected

Part d-1)

Project A: NPV

Year	CF	Discount Factor		Discounted CF
0	$    -5,400.00	1/(1+0.1)^0=	1	1*-5400=	$     -5,400.00
1	$      1,100.00	1/(1+0.1)^1=	0.909090909	0.909090909090909*1100=	$       1,000.00
2	$      1,100.00	1/(1+0.1)^2=	0.826446281	0.826446280991735*1100=	$          909.09
3	$      3,200.00	1/(1+0.1)^3=	0.751314801	0.751314800901578*3200=	$       2,404.21
				NPV = Sum of all Discounted CF	$     -1,086.70

Project B: NPV

Year	CF	Discount Factor		Discounted CF
0	$    -1,400.00	1/(1+0.1)^0=	1	1*-1400=	$     -1,400.00
1	$                   -	1/(1+0.1)^1=	0.909090909	0.909090909090909*0=	$                    -
2	$      1,400.00	1/(1+0.1)^2=	0.826446281	0.826446280991735*1400=	$       1,157.02
3	$      2,200.00	1/(1+0.1)^3=	0.751314801	0.751314800901578*2200=	$       1,652.89
4	$      3,200.00	1/(1+0.1)^4=	0.683013455	0.683013455365071*3200=	$       2,185.64
				NPV = Sum of all Discounted CF	$       3,595.56

Project C: NPV

Year	CF	Discount Factor		Discounted CF
0	$    -5,400.00	1/(1+0.1)^0=	1	1*-5400=	$     -5,400.00
1	$      1,100.00	1/(1+0.1)^1=	0.909090909	0.909090909090909*1100=	$       1,000.00
2	$      1,100.00	1/(1+0.1)^2=	0.826446281	0.826446280991735*1100=	$          909.09
3	$      3,200.00	1/(1+0.1)^3=	0.751314801	0.751314800901578*3200=	$       2,404.21
4	$      5,200.00	1/(1+0.1)^4=	0.683013455	0.683013455365071*5200=	$       3,551.67
				NPV = Sum of all Discounted CF	$       2,464.97

Part d-2) Projects B and C have positive NPV

Part e) Payback period completely ignores the CF after the investment is recovered so even if it becomes negative and is a high drawback of the project, this method would suggest that this project should be accepted. Therefore the given statement is false