Homework Sourse1 Suppose your firm is considering two mutually exclusive re
1. Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively.
Time
0
1
2
3
Project A Cash Flow
?1,000
300
400
700
Project B Cash Flow
?500
200
400
300
Use the discounted payback decision rule to evaluate these projects; which one(s) should be accepted or rejected?
| Time | 0 | 1 | 2 | 3 |
| Project A Cash Flow | ?1,000 | 300 | 400 | 700 |
| Project B Cash Flow | ?500 | 200 | 400 | 300 |
Solution
A:
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).
2+(396.69/525.92)
=2.75 years(Approx).
B:
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).
1+(318.18/330.58)
=1.96 years(Approx).
Hence since projects are mutually exclusive,B must be selected only having lower discounted payback period.
| Year | Cash flows | Present value@10% | Cumulative Cash flows |
| 0 | (1000) | (1000) | (1000) |
| 1 | 300 | 272.73 | (727.27) |
| 2 | 400 | 330.58 | (396.69) |
| 3 | 700 | 525.92 | 129.23(Approx). |
