Davis Corporation is faced with two independent investment opportunities. The Corporation has an investment policy, which requires acceptable projects to recover all costs within 3 years. The Corporation uses the discounted payback method to assess potential projects and utilizes a discount rate of 10 percent. The cash flows for the two projects are:
Time Project A Project B -
0-100,000-$80,000
140,000 50,000
240,000 20,000
340,000 30,000
430,000 0
Which investment project(s) does the company invest in?
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A. B. C. D.A
The sum of the PVs of the t = 1, t = 2, and t = 3 cash flows at t = 0 for Project A is $99,474.08. Thus, the discounted payback period of Project A exceeds 3 years and Project A is not acceptable. The PVs of the t = 1, t = 2, and t = 3 cash flows at t = 0 for Project B are $45,454.55, $16,528.93, and $22,539.44, respectively.
These PVs sum to $84,522.92, which is greater than the cost of the project, indicating that the discounted payback period is less than 3 years. Thus, Project B will be undertaken.