Question

Buy Coastal, Inc., imposes a payback cutoff of three years for its international investment projects. Suppose the company has the following two projects available. Project A has payback period of years, while project B has a payback period of years. Therefore, it should (Click to select)rejectaccept project A and (Click to select)rejectaccept project B. (Round your answers to 3 decimal places. (e.g., 32.162))

Year Cash Flow (A) Cash Flow (B)
0 −$40,000 −$60,000
1 19,000 14,000
2 25,000 17,000
3 18,000 24,000
4 6,000 270,000

Answer 1

After evaluating the cash flows, both Project A and Project B should be rejected by Buy Coastal, Inc., as they do not meet the required payback cutoff of three years.

Step-by-step explanation:

Based on the information provided, Buy Coastal, Inc. should reject both Project A and Project B because both projects exceed the company's payback cutoff of three years. To evaluate an investment based on payback period, one must calculate how long it will take for the project to generate enough cash flow to recover the initial investment. The payback period is simply the time it takes for the cumulative cash flow to become positive.

The cash flows for Project A are -$40,000 in Year 0, $19,000 in Year 1, $25,000 in Year 2, and $18,000 in Year 3. Adding these cash flows cumulatively, we find that after three years, Project A has not paid back the initial investment since the total is only $19,000 + $25,000 + $18,000 = $62,000, which is short of the $40,000 initial cost.

Similarly, for Project B, with a Year 0 cash flow of -$60,000, and subsequent cash flows of $14,000, $17,000, and $24,000 for Years 1 to 3 respectively, the cumulative cash flow after three years is $14,000 + $17,000 + $24,000 = $55,000. This also does not cover the initial investment of $60,000.

Both projects fail to meet the payback time criteria set by the company.