Should the following project be accepted if the company requires both a [endif]p
ID: 2652305 • Letter: S
Question
Should the following project be accepted if the company requires both a
[endif]payback on discounted cash flows within three years (assuming a hurdle rate of 10%)
[endif]payback on nominal dollars within three years
Project cash flows are:
Cost of the project in year zero is $50,000
End of year one inflow = 15,000
End of year two inflow = 20,000
End of year three inflow = 25,000
End of year four inflow = 30,000
a.
Yes, the project should be accepted because both the undiscounted and discounted payback periods are less than three years.
b.
No, while the undiscounted cash flow payback is less than three years the payback for discounted cash flows exceeds three years.
c.
No, both the undiscounted and discounted cash flow paybacks exceed three years.
d.
No, while the discounted cash flow payback is less than three years the payback for undiscounted cash flows exceeds three years.
Explanation / Answer
Calculation of Undiscounted and Discounted Pay Back Period:
Here Undiscounted Cash Flow Payback is less than three years while Discounted Payback Period is more than three Years.
So, the correct Option is b.
Year Outflow / Inflow Cumulative Cash Flow Discount Factor(10%) Discounted CF Cumulative Discounted CF 0 -50,000 -50,000 0 -50,000 -50,000 1 15,000 -35,000 0.90909 13,636.35 -36,363.65 2 20,000 -15,000 0.82645 16,529 -19,834.65 3 25,000 10,000 0.75131 18,782.75 -1,051.90 4 30,000 40,000 0.68301 20,490.30 19,438.40