Question

Davis Corporation has an investment policy that requires acceptable projects to recover all costs within 3 years. The corporation uses the discounted payback method to assess potential projects and uses a WACC of 10%. The cash flows for two independent projects are shown below: Year | Cash Flow A Cash Flow B - 100.000 |-$80,000 40,000 50.000 40,000 20,000 40,000 30.000 30,000 In which investment project(s) should the company invest? Project A only. Neither Project A nor Project B. Project A and Project B. O Project B only. Cannot be determined without additional information

Answer 1

DIscounted Payback period is the period in which initial invetsment is recovered after considering the time value of money.

Project A:

Year	Opening Bal	CF	PVF @10%	Disc CF	Clsoing BAL
1	$ 1,00,000.00	$ 40,000.00	$      0.91	$ 36,363.64	$ 63,636.36
2	$    63,636.36	$ 40,000.00	$      0.83	$ 33,057.85	$ 30,578.51
3	$    30,578.51	$ 40,000.00	$      0.75	$ 30,052.59	$        525.92
4	$         525.92	$ 30,000.00	$      0.68	$ 20,490.40	$ -19,964.48

Disc PBP = Year in which least +ve CB + [ CB in that Year / Disc CF in Next year ]

= 3 + [ 525.92 / 20490.4 ]

= 3 + 0.03

= 3.03 Years

Project B:

Year	Opening Bal	CF	PVF @10%	Disc CF	Clsoing BAL
1	$ 80,000.00	$ 50,000.00	0.9091	$ 45,454.55	$ 34,545.45
2	$ 34,545.45	$ 20,000.00	0.8264	$ 16,528.93	$ 18,016.53
3	$ 18,016.53	$ 30,000.00	0.7513	$ 22,539.44	$ -4,522.92

Disc PBP = Year in which least +ve CB + [ CB in that Year / Disc CF in Next year ]

= 2 + [ 18016.53 / 22539.44]

= 2+ 0.80

= 2.80 Years

As Max Disc PBP acceptable is Years3. Hence Project B alone can be selected.

Option D is correct.