Question

Compute the Payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent and the maximum allowable payback is 3 years. 

Time:	0	1	2	3	4	5
Cash flow:	-2,800	675	550	850	750	700

Multiple Choice 

• 2.97 years, Accept 

• 3.97 years, Accept 

• 2.97 years, Reject 

• 3.97 years, Reject

Answer 1

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

Payback period= 3 years + $725/ $750

                         = 3 years + 0.97

                         = 3.97 years.

Since the payback period of the project is more than the maximum allowable payback of 3 years, the project must be rejected.

Hence, the answer is option d.

In case of any query, kindly comment on the solution.