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 7 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively. Time: Cash flow -$5,000 $1,270 $2.470 $1,670 $1,590 $1,470 $1,270 Use the payback decision rule to evaluate this project. (Round your answer to 2 decimal places.) Payback years Should it be accepted or rejected? O Rejected Accepted

Solution

Payback period refers to the minimum time period in which the intial investment in the project is recovered. Lower the payback period, better it is.

Calculation of pay back period

Payback period = 2 + (1,260/1,670)

= 2 + 0.75

= 2.75 years

Payback period of the project is = 2.75 years

Maximum allowable payback period is 3.5 years. Since the payback period of the project (2.75 years) is less than the maximum allowable payback period (3.5 years), hence the project should be accepted.

Year	Cash flow	Cumulative cash flows
1	1,270	1,270
2	2,470	3,740
3	1,670	5,410
4	1,590	7,000
5	1,470	8,470
6	1,270	9,740