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 2.0 and 3.0 years, respectively.

Time:	0	1	2	3	4	5	6
Cash flow:	–$4,700	$1,130	$2,330	$1,530	$1,530	$1,330	$1,130

Use the discounted payback decision rule to evaluate this project. (Round your answer to 2 decimal places.)

Answer 1

Year	Cash flows	Present value@9%	Cumulative Cash flows
0	(4700)	(4700)	(4700)
1	1130	1036.7	(3663.3)
2	2330	1961.11	(1702.19)
3	1530	1181.44	(520.75)
4	1530	1083.89	563.14
5	1330	864.41	1427.55
6	1130	673.78	2101.33

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+(520.75/1083.89)

=3.48 years(Approx).

Hence since discounted payback is greater than 3 years;project must be rejected.