Sunday, 3 August 2014

Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

Year Cash Flow A Cash Flow B
0 –$ 62,000      –$ 107,000     
1   25,500        27,500     
2   33,200        32,500     
3   27,500        26,500     
4   13,500        233,000     


Requirement 1:
What is the payback period for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

  Payback period  
  Project A years  
  Project B years  


Requirement 2:
Should it accept either of them?
 
Accept project A and reject project B  


Explanation: 1: 
Project A has cash flows of:
 
Cash flows = $25,500 + 33,200
Cash flows = $58,700
 
during the first two years. The cash flows are still short by $3,300 of recapturing the initial investment, so the payback for Project A is:
 
Payback = 2 + ($3,300 / $27,500)
Payback = 2.12 years
 
Project B has cash flows of:
 
Cash flows = $27,500 + 32,500 + 26,500
Cash flows = $86,500
 
during the first three years. The cash flows are still short by $20,500 of recapturing the initial investment, so the payback for Project B is:
 
Payback = 3 + ($20,500 / $233,000)
Payback = 3.09 years
 
2:
Using the payback criterion and a cutoff of 3 years, accept project A and reject project B.