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 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively.

770

Use the payback decision rule to evaluate this project; should it be accepted or rejected?

0 years, accept

1.04 years, accept

2.71 years, reject

4.00 years, reject

Solution

PAY BACK PERIOD

= 2 + (-550 / 770)

= 2 + 0.71

= 2.71 YEARS

AS MAXIMUM ALLOWABLE PAY BACK PERIOD IS 2 YEARS , THE PROJECT SHOULD BE REJECTED.

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DISCOUNTED PAYBACK PERIOD

DISCOUNTED PAY BACK PERIOD

= 3 + (-$120.72 / $489.34)

= 3 + 0.25

= 3.25 YEARS

AS MAXIMUM ALLOWABLE DISCOUNTED PAY BACK PERIOD IS 3 YEARS , THE PROJECT SHOULD BE REJECTED.