Question

Your firm is considering a project with the following cash flows. The firm has a weighted average cost of capital of 6%. The firm usually accepts projects that payback in 4 years or less. Using what you know about payback period, which of the following statements is true about the firm's project selection? Year CF 0 -$2,000,000 1 $800,000 2 $600,000 3 -$200,000 4 $1,800,000 5 $400,000 6 $300,000

Answer 1

А. Н. B с D E F G IF ANY QUERY, FEEL FREE TO ASK THEM AND GET RESOLVED 1 2 3 Solution: 4 5 Calculate IRR and Payback Period 6 Year Cash Flow Cumulative Cash Flow 7 8 0 9 1 10 11 12 2 3 -2000000 800000 600000 -200000 1800000 400000 300000 -1200000 -600000 -800000 1000000 1400000 1700000 4 13 5 6 14 15 16 17 18 1 IRR 22.00% =IRR(C8:C14) Formula 19 2 Payback is the period within which intial outlay or initial investment in a Project is recovered. 20 21 22 23 24 25 26 27 28 29 Payback = Previous Year Cumulative CF of Previous Year (ignore +/- sign) CF of Current year where, Previous Year = Year before year in which cumulative CF turn positive from negative Current Year = Year in which cumulative CF turns positive from negative Hence, using above formula we get, Payback = 3 + 800000 1800000 30 + 0.44 31 32 33 3 3.44 Years Project has payback of 3.44 year which is less than 4 year and IRR is 22.00% which greater than cost of capital 6%. Hence, project must be accepted. 34 35 36 Hence, 4th option None of the above is correct.