Stern Associates is considering a project that has the follo

Stern Associates is considering a project that has the following cash flow data. What is the project\'s payback? Cash flows $975 $300 $310 S320 S330 $340 A) 2.54 years B) 2.42 years C) 3.83 years O D) 3.14 years E) 3.61 years Save Question 9 (1 point) OType here to search

Solution

Payback period is the time upto which initial cost is recovered.Discounted payback is also same .But, there is difference between payback and discounted payback that discounted payback considers time value of money whereas payback period does not. 1) Payback Peiod D) 3.14 Years Working: Year Cash flow Cumulatiev Cash flow 0 $       -975 $       -975 1 $         300 $       -675 2 $         310 $       -365 3 $         320 $         -45 4 $         330 $         285 5 $         340 $         625 In Year 4, cumulative cash flows is positive.It means in Year 4, initial cost is recovered back. Payback Period = 3+(45/330) =            3.14 Years 2) Payback Peiod D) 1.47 Years Working: Year Cash flow Discounted Factor Present Value Cumulative Present value of cash flow 0 $       -650         1.000 $       -650 $      -650 1 $         500         0.909 $         455 $      -195 2 $         500         0.826 $         413 $        218 3 $         500         0.751 $         376 $        593 In Year 2, cumulative present value of cash flows is positive.It means in Year 2, initial cost is recovered back. Discounted Payback Period = 1+(195/413) =           1.47 Years