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Calculation of Payback Period and NPV

What is the payback period on each of the following projects?

project time 0 1 3 4
a -5000 1000 1000 3000 0
b -1000 0 1000 2000 3000
c -5000 1000 1000 3000 5000

Given that you wish to use the payback rule with a cutoff period of 2 years, which project would you accept?

If you ue a cutoff period of 3 years, which projects would accept?

If the opportunity cost of capital is 10%, which projects have positive NPV's?

True or false does payback gives too much weight to cash flows that occur after the cutoff date?

Solution Preview

The attached Excel file contains the answers to the 4 questions.

What is the payback period on each of the following projects?
Project a

Year Cash flow Cumulative cash flow

0 -5000 (5,000)
1 1000 (4,000)
2 1000 (3,000)
3 3000 0 Payback period= 3 years
4 0
0

Payback period of Project a 3 years

Project b

Year Cash flow Cumulative cash flow

0 -1000 (1,000)
1 0 (1,000)
2 1000 0 Payback period= 2 years
3 2000 2,000
4 3000
5000

Payback period of Project ...

Solution Summary

The solution illustrates steps required for the calculation of NPV and Payback period.

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