Question

13.4: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 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively.

Time:	0	1	2	3	4	5	6
Cash flow:	–$5,200	$1,290	$2,490	$1,690	$1,690	$1,490	$1,290

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

Answer 1

Year	Cash flows	Present value@8%	Cumulative Cash flows
0	(5200)	(5200)	(5200)
1	1290	1194.44	(4005.56)
2	2490	2134.77	(1870.79)
3	1690	1341.58	(529.21)
4	1690	1242.20	712.99
5	1490	1014.07	1727.06
6	1290	812.92	2539.98(Approx)

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+(529.21/1242.20)

=3.43 years(Approx)

Hence since discounted payback is less than 4.5 years;project must be accepted.