Question

Should Tangshan Mining company accept a new project if the​ company's maximum payback is 3.5 years and the​ project's initial afterminustax cost is​ $5,000,000 followed by afterminustax operating cash inflows of​ $1,800,000 in year​ 1, $1,900,000 in year​ 2, $700,000 in year​ 3, and​ $1,800,000 in year​ 4? A. ​No, since the payback period of the project is more than the maximum acceptable payback period. B. ​Yes, since the risk exposure of the project is less than the maximum acceptable risk exposure. C. ​Yes, since the payback period of the project is less than the maximum acceptable payback period. D. ​No, since the risk exposure of the project is more than the maximum acceptable risk exposure.

Answer 1

The correct option is (C)

Step-by-step explanation:

Payback period is the time period within which initial investment is recovered.

Here, maximum payback period is 3.5 years.

Initial investment is $5,000,000

It is a case of uneven cash flow. So, cumulative cash flow need to be computed. The entire calculation is shown in the spreadsheet below.

cumulative cash flow is positive in year 4.

so, payback period =
`3+(600,000)/(1,800,000)`

= 3.33 years

Since, maximum payback period is 3.5 and actual payback period is below the maximum limit, project should be accepted.