Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent and the maximum allowable payback is four years.
$$\begin{array}{l}
\begin{array} {| l | l | l | l | l | l | l |}
\hline\text {Time: }&0&1&2&3&4&5\
\hline\text {Cash flow:}&-1,000&-75&100&100&0&2,000\\hline
\end{array}
\end{array}$$
A) 3.4375 years, accept
B) 3.78 years, reject
C) 4.4375 years, reject
D) 4.78 years, accept

Question

Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent and the maximum allowable payback is four years.
$$\begin{array}{l}
\begin{array} {| l | l | l | l | l |  l |  l |}
\hline\text {Time: }&0&1&2&3&4&5\
\hline\text {Cash flow:}&-1,000&-75&100&100&0&2,000\\hline
\end{array}
\end{array}$$
A) 3.4375 years, accept
B) 3.78 years, reject
C) 4.4375 years, reject
D) 4.78 years, accept

Quizplus · Accepted Answer

The payback period is calculated by adding up the cash flows until the initial investment is recovered. Here, the cumulative cash flows are as follows: Year 0: -$1,000, Year 1: -$1,075 (adding -$75), Year 2: -$975 (adding $100), Year 3: -$875 (adding another $100), and by Year 4, the cash flow is $0, so we still haven't recovered the investment. It's not until Year 5 that we get a large inflow of $2,000, which recovers the investment and provides a return. Since the payback period exceeds the maximum allowable payback of four years, the project should be rejected based on the payback criterion.

Compute the Payback Statistic for Project X and Recommend Whether