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A firm is considering the following projects
A firm is considering the following projects. Its opportunity cost of capital is 9%.
Cash Flows,
Project Time: 0 1 2 3 4
A -6,200 +1,300 +1,300 +3,600 0
B -2,200 0 +2,200 +2,600 +3,600
C -6,200 +1,300 +1,300 +3,600 +6,200
a) What is the payback period on each project?
What is the discounted payback period on each project? (Round your answers to 2 decimal places).
b) Given that you wish to use the payback rule with a cutoff period of 2 years, which projects would you accept?
c) If you use a cutoff period of 3 years with the discounted payback rule, which projects would you accept?
d) Which projects have positive NPVs?
e) "Payback gives too much weight to cash flows that occur after the cutoff date." True or false?
Expert Solution
a) Payback period for project A = 3 years
Project B = 2 years
Project C = 3 years
NPV for project A = -$1,133.29
Project B = $4,209.70
Project C = $3,258.94
Discounted payback period for project A is greater than the 4 years because it will not recover in given period.
Discounted payback period for project B = 2 years
Project C = 3.26 years
b) If we use payback period rule with a cutoff period of 2 years the project B will be selected.
c) If we use discounted payback period rule with a cutoff period of 3 years the project B will be selected because it has lower payback period than required payback period.
d) Project B & C have positive NPV.
e) False, payback does not give any weight to cash flows that occur after the cutoff date.
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