Question

Problem 8-23 (bookmatch) Question Help • You are evaluating a project that will cost $500,000, but is expected to produce cash flows of $125,000 per year for 10 years, with the first cash flow in one year. Your cost of capital is 11% and your company's preferred payback period is three years or less. a. What is the payback period of this project? b. Should you take the project if you want to increase the value of the company? a. What is the payback period of this project? The payback period is years. (Round to two decimal places.)

Answer 1

a. The payback period represents the time period in which the initial investment in a project is recovered.

The payback period is computed as follows:

The cash flows from the project for 4 years are as follows:

= $ 125,000 x 4

= $ 500,000

This implies that the payback period is 4 years , since the project's initial investment of $ 500,000 is recovered in 4 years.

b. In this case we need to compute the NPV of the project, which is computed as follows:

= - $ 500,000 + $ 125,000 / 1.11¹ + $ 125,000 / 1.11² + $ 125,000 / 1.11³ + $ 125,000 / 1.11⁴ + $ 125,000 / 1.11⁵ + $ 125,000 / 1.11⁶ + $ 125,000 / 1.11⁷ + $ 125,000 / 1.11⁸ + $ 125,000 / 1.11⁹ + $ 125,000 / 1.11¹⁰

= $ 236,154 Approximately

Since the NPV of the project is positive, we shall take the project.

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