Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). The company accepts all projects with a payback period of 2 years or less.
A) The payback rule would reject this project because of its risks are too high.
B) The payback rule would reject this project because all negative cash flows are added together.
C) If strictly applied, the payback rule would reject this project.
D) If strictly applied, the payback rule would accept this project.

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the initial investment to be recovered from the cash flows. In this case, the initial investment of $115,000 is recovered within the first year itself with a cash flow of $140,000, which is less than 2 years. Therefore, the payback rule would accept this project.

Project Black Swan Requires an Initial Investment of $115,000