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Here are the expected cash flows for three projects: Year: 4 Project A B C a - 5,500 1,500 5,500 Cash Flows (dollars) 1 2 3 + 1,125 + 1,125 + 3,250 + 1,500 + 2,250 + 1,125 + 1,125 + 3,250 + 3,250 + 5,250 a
Here are the expected cash flows for three projects: Year: 4 Project A B C a - 5,500 1,500 5,500 Cash Flows (dollars) 1 2 3 + 1,125 + 1,125 + 3,250 + 1,500 + 2,250 + 1,125 + 1,125 + 3,250 + 3,250 + 5,250 a. What is the payback period on each of the projects? b. If you use the payback rule with a cutoff period of 2 years, which projects will you accept? c. If you use a cutoff period of 3 years, which projects will you accept? d-1. If the opportunity cost of capital is 11%, calculate the NPV for projects A, B, and C. (Negative amounts should be Indicated by a minus sign. Do not round Intermediate calculations. Round your answers to 2 decimal places.) d-2. Which projects have positive NPVS? e. "Payback gives too much weight to cash flows that occur after the cutoff date." True or false? Project A 3 Years a. Payback period b. If you use the payback rule with a cutoff period of 2 years, which projects will you accept? c. If you use a cutoff period of 3 years, which projects will you accept? d-1. If the opportunity cost of capital is 11%, calculate the NPV for projects A, B, and C. d-2. Which projects have positive NPVs? e. "Payback gives too much weight to cash flows that occur after the cutoff date." True or false? Project B Project C 2 Years 3 Years Project B Project A and Project C 3,503.49 $ 2,261.30 Project B and Project C False $ (1,197.04) $
Expert Solution
a) Payback period
Project A
Statement showing cummulative cash flow
| Year | Cash flow | Cummulative cash flow |
| 1 | 1125 | 1125 |
| 2 | 1125 | 2250 |
| 3 | 3250 | 5500 |
| 4 | 0 | 5500 |
Since in year 3, initialinvestment of $ 5500 is being recovered , payback period = 3 years
Project B
Statement showing cummulative cash flow
| Year | Cash flow | Cummulative cash flow |
| 1 | 0 | 0 |
| 2 | 1500 | 1500 |
| 3 | 2250 | 3750 |
| 4 | 3250 | 7000 |
Since in year 2, initialinvestment of $ 1500 is being recovered , payback period = 2 years
Project C
Statement showing cummulative cash flow
| Year | Cash flow | Cummulative cash flow |
| 1 | 1125 | 1125 |
| 2 | 1125 | 2250 |
| 3 | 3250 | 5500 |
| 4 | 5250 | 10750 |
Since in year 3, initialinvestment of $ 5500 is being recovered , payback period = 3 years
b) If cutoff for payback period is 2 years , than project B will only be selected as it has payback period of 2 years.
c) If cutoff for payback period is 3 years. Than all the projects i.e Project A , Project B and Project C can be selected
d-1)
Project A
Statement showing NPV
| Year | Cash flow | PVIF @ 11% | PV |
| A | B | A x B | |
| 0 | -5500 | 1.0000 | -5500.00 |
| 1 | 1125 | 0.9009 | 1013.51 |
| 2 | 1125 | 0.8116 | 913.08 |
| 3 | 3250 | 0.7312 | 2376.37 |
| 4 | 0 | 0.6587 | 0.00 |
| NPV = Sum of PV | -1197.04 |
Thus NPV of project A = $ - 1197.04
Project B
Statement showing NPV
| Year | Cash flow | PVIF @ 11% | PV |
| A | B | A x B | |
| 0 | -1500 | 1.0000 | -1500.00 |
| 1 | 0 | 0.9009 | 0.00 |
| 2 | 1500 | 0.8116 | 1217.43 |
| 3 | 2250 | 0.7312 | 1645.18 |
| 4 | 3250 | 0.6587 | 2140.88 |
| NPV = Sum of PV | 3503.49 |
Thus NPV of project B = $ 3503.49
Project C
Statement showing NPV
| Year | Cash flow | PVIF @ 11% | PV |
| A | B | A x B | |
| 0 | -5500 | 1.0000 | -5500.00 |
| 1 | 1125 | 0.9009 | 1013.51 |
| 2 | 1125 | 0.8116 | 913.08 |
| 3 | 3250 | 0.7312 | 2376.37 |
| 4 | 5250 | 0.6587 | 3458.34 |
| NPV = Sum of PV | 2261.30 |
Thus NPV of project C = $ 2261.30
d-2) Project C and Project C have positive NPV
e) False
One of limitation of payback period is that it does not consider cash flow after cut off period
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