Question

Should Tangshan Mining company accept a new project if its maximum payback is 3.5 years and its initial after tax cost is​ $5,000,000 and it is expected to provide 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?

Answer 1

Answer:

Yes, Tangshan Mining company should accept the project.

Explanation:

Payback period is the number of years it takes for a project's expected cash inflows to recover the initial investment amount.

Tangshan company's required payback period = 3.5 years

Year             CF                       Net CF

0             -5,000,000        -5,000,000

1               1,800,000          -3,200,000

2              1,900,000          -1,300,000

3                700,000           -600,000

4               1,800,000            1,200,000

Payback period = last year with -net CF +(absolute net CF that year /total CF the following year)

Payback period = 3 + (600,000 / 1,800,000)

=3 + 0.33

= 3.33 years

Since 3.33 years is lower than the required payback period of 3.5 years, Tangshan Mining company should ACCEPT the new project; it will take less years to fully recover the initial amount investment.