Suppose your firm is considering investing in a project with

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 14 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,120 60 540 740 740 340 740 Use the payback decision rule to evaluate this project; should it be accepted or rejected?

Solution

This would continue till year 6.

Hence 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+(520/740)

=2.70 years(Approx).

Hence since payback is greater than 2 years;project must be rejected.