Question

answer questions a-c thoroughly with no excel calculations please :)

A firm is considering the following projects. Its opportunity cost of capital is 10%, Cash Flows, $ Project Time: 0 -5,800 -1,800 -5,800 +1,200 O +1,200 +1,200 +1,800 +1,200 +3,400 +2,400 +3,400 +3,400 +5,800 a. What is the payback period on each project? Project A 3 years Project B 2 years Project C 3 years What is the discounted payback period on each project? (Round your answers to 2 decimal places. If any of the projects does not pay back on a discounted basis, enter zero ("O").) Project A D O years Project B years Project C C years b. Given that you wish to use the payback rule with a cutoff period of 2 years, which projects would you accept? (Project B c. If you use a cutoff period of 3 years with the discounted payback rule, which projects would you accept? Project B 9

Answer 1

First let us find the discount factor at 10% for 4 years.

Formula:

Discount Factor = 7 (1 + i)"

For year 0, Discount Factor = 1

For year 1:

Discount Factor = 1 / (1+0.1)¹ = 0.9091

For year 2:

Discount Factor = 1 / (1+0.1)² = 0.8264

For year 3:

Discount Factor = 1 / (1+0.1)³ = 0.7513

For year 4:

Discount Factor = 1 / (1+0.1)⁴ = 0.6830

Now let us put all the information in tabular form, which will gives us a clear understanding.

Project A Time Cash Flows Discount Factor Discounted Cashflow Cumulative Cash Inflow Cumulative Discounted Cash inflow -5800 1200 -5800 1090.91 991.74 2554.47 0.9091 0.8264 0.7513 1200 1200 2400 5800 1090.91 2082.64 4637.11 3400 Project B Time Cash Flows Discount Factor Discounted Cashflow Cumulative Cash Inflow Cumulative Discounted Cash inflow -1800 -1800 WNO 1800 2400 3400 0.9091 0.8264 0.7513 0.6830 1487.60 1803.16 2322.25 1800 4200 7600 1487.60 3290.76 5613.00

Project C Time Cash Flows Discount Factor Discounted Cashflow Cumulative Cash Inflow Cumulative Discounted Cash inflow -5800 1200 1200 3400 5800 0.9091 0.8264 0.7513 0.6830 -5800 1090.91 991.74 2554.47 3961.48 1200 2400 5800 11600 1090.91 2082.64 4637.11 8598.59

With these information we can answer the questions:

a) Payback Period:

You can refer the column "cumulative Cash inflow"

Project A: 3 Years

Project B: 2 Years

Project C: 3 Years

Discounted Payback Period:

You can refer the column "Cumulative Discounted Cash inflow"

Project A: 0 Years

Project B: 3 Years

Project C: 4 Years

b) Which project to accept if payback if cut off period is 2 years?

Answer: Project B, since it is the only project whose cut off period is 2 years.

c) Which project to accept if discounted payback cut off period is 3 years?

Answer: Project B, since it is the only project whose cut off period is 3 years (using discounted payback rule).

Note: I have not used any excel calculations here, cumulative cash flows are nothing but the sum of current cash flows and previous years cash flow.