Question

2. Calculating Payback (LO2) An investment project provides cash inflows of $585 per year for eight years. What is the project payback period if the initial cost is $1,700? What if the initial cost is $3,300? What if it is $4,900? 3. Calculating Payback (LO2) McKernan Inc. imposes a payback cutoff of three years for its international investment projects. If the company has the following two projects available, should they accept either of them? -$60,000 Year Cash Flow (A) Cash Flow (B) $ 70,000 23,000 15,000 28.000 18,000 21,000 26,000 8.000 230,000 Click here for a description of Table: Questions and Problems 3. on 0 4. Calculating Discounted Payback (L03) An investment project has annual cash intlows of $4,200. $5.300. $6.100, and $7.400. and a discount rate of 14 percent. What is the discounted payback period for these cash flows if the initial cost is $7,000? What if the initial cost is $ 10 000? What if it is $13.000? 5. Calculating Discounted Payback (L03) An investment project costs $10.000 and has annual cash flows of 62.900 for six years. What is the discounted payback period if the

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Answer 1

3. Payback period is the time required for the operating cash inflows to recover the initial investment in a project.

First we will calculate the payback period of each projects.

Project A:

Here, initial investment = $60000

Cumulative cash flows after year 1 = $23000

Cumulative cash flows after year 2 = $23000 + $28000 = $51000

Cumulative cash flows after year 3 = $23000 + $28000 + $21000 = $72000

The cumulative cash flows reach the initial investment amount of $60000 sometime in year 3.

Therefore the payback period would be more than 2 years and less than 3 years. Steps in the calculation of payback period are given below:

a. Amount of cash flow in year 3 needed to reach $60000 cumulative cash flows:

$60000 - $51000 (year 2's cumulative cash flow amount) = $9000

b. Percentage of year 3 until cumulative amount of $60000 is reached:

$9000 / $21000 = 0.428571

c. Payback period = 2 + 0.428571 = 2.4286 years

Project B:

Here, initial investment = $70000

Cumulative cash flows after year 1 = $15000

Cumulative cash flows after year 2 = $15000 + $18000 = $33000

Cumulative cash flows after year 3 = $15000 + $18000 + $26000 = $59000

Cumulative cash flows after year 4 = $15000 + $18000 + $26000 + $230000 = $289000

The cumulative cash flows reach the initial investment amount of $60000 sometime in year 4.

Therefore the payback period would be more than 3 years and less than 4 years.

Since the cut off time of the company is 3 years, so it should accept the project with payback period less than 3 years.

Project A has payback period less than 3 years, so project A should be accepted.