Traditional Payback Period – The time required to recover the initial investment from a project’s expected cash

flows. [Time value of money is not considered]

Discounted Payback Period – The time required to recover the initial investment from a project’s discounted
cash flows. [Time value of money is considered]

Solution of Problem 9-12

7500 7500 7500 7500 7500
1 + 2 + 3 + 4 +
NPV (Truck) = – 22430
(1+0.14) (1+0.14) (1+0.14) (1+0.14) (1+0.14)5

= 6578.95 + 5771.01 + 5062.29 + 4440.60 + 3895.26 – 22430

= 25748.11 – 22430

= $ 3318.11
5100 5100 5100 5100 5100
NPV (Pulley) = 1
+ 2
+ 3
+ 4
+ – 17100
(1+0.14) (1+0.14) (1+0.14) (1+0.14) (1+0.14)5

= 4473.68 + 3924.28 + 3442.35 + 3019.61 + 2648.78 – 17100

= 17508.70 – 17100

= $ 408.70

Based on NPV, both the projects should be accepted as the projects are independent.
Payback Period (Truck)
Year 1 Year 2 Year 3 Year 4 Year 5
Expected Cash Flows 7500 7500 7500 7500 7500
Discounted Cash Flows 6578.95 5771.01 5062.29 4440.60 3895.26

Amount recovered till year 2 = $ 15000 [7500 + 7500]

Traditional Payback Period

Remaining amount = 22430 – 15000 [initial Investment – amount recovered]

= $ 7430
7430 Remaining amount
Time required to recover the remaining amount = [ ]
7500 Expected cash flow in year 3

= 0.99 years
Therefore, traditional payback period (truck) = (2 + 0.99) years = 2.99 years

Amount recovered till year 4 = $ 21852.85 [6578.95 + 5771.01 + 5062.29 + 4440.60]

Discounted Payback Period

Remaining amount = 22430 – 21852.85 [initial Investment – amount recovered]

= $ 577.15
577.15 Remaining amount
Time required to recover the remaining amount = [ ]
3895.26 Discounted cash flow in year 5

= 0.15 years
Therefore, discounted payback period (truck) = (4 + 0.15) years = 4.15 years
Payback Period (Pulley)
Year 1 Year 2 Year 3 Year 4 Year 5
Expected Cash Flows 5100 5100 5100 5100 5100
Discounted Cash Flows 4473.68 3924.28 3442.35 3019.61 2648.78

Amount recovered till year 3 = $ 15300 [5100 + 5100 + 5100]

Traditional Payback Period

Remaining amount = 17100 – 15300 [initial Investment – amount recovered]

= $ 1800
1800 Remaining amount
Time required to recover the remaining amount = [ ]
5100 Expected cash flow in year 4

= 0.35 years
Therefore, traditional payback period (pulley) = (3 + 0.35) years = 3.35 years

Amount recovered till year 4 = $ 14859.92 [4473.68 + 3924.28 + 3442.35 + 3019.61]

Discounted Payback Period

Remaining amount = 17100 – 14859.92 [initial Investment – amount recovered]

= $ 2240.08
2240.08 Remaining amount
Time required to recover the remaining amount = [ ]
2648.78 Discounted cash flow in year 5

= 0.85 years
Therefore, discounted payback period (pulley) = (4 + 0.85) years = 4.85 years
Solution of Problem 9-14
4500 4500 4500 4500 4500
NPV (Project P) = 1
+ 2
+ 3
+ 4
+ – 15000
(1+0.14) (1+0.14) (1+0.14) (1+0.14) (1+0.14)5

= 3947.37 + 3462.60 + 3037.37 + 2664.36 + 2337.16 – 15000

= 15448.86 – 15000

= $ 448.86
11100 11100 11100 11100 11100
NPV (Project Q) = + + + + – 37500
(1+0.14)1 (1+0.14)2 (1+0.14)3 (1+0.14)4 (1+0.14)5

= 9736.84 + 8541.09 + 7492.18 + 6572.09 + 5764.99 – 37500

= 38107.19 – 37500

= $ 607.19

If the projects are independent, both the projects should be selected.

If the projects are mutually exclusive, Project Q should be selected.

Payback Period (Project P)
Year 1 Year 2 Year 3 Year 4 Year 5
Expected Cash Flows 4500 4500 4500 4500 4500
Discounted Cash Flows 3947.37 3462.60 3037.37 2664.36 2337.16

Amount recovered till year 3 = $ 13500 [4500 + 4500 + 4500]

Traditional Payback Period

Remaining amount = 15000 – 13500 [initial Investment – amount recovered]

= $ 1500
1500 Remaining amount
Time required to recover the remaining amount = [ ]
4500 Expected cash flow in year 4

= 0.33 years
Therefore, traditional payback period (Project P) = (3 + 0.33) years = 3.33 years

Amount recovered till year 4 = $ 13111.70 [3947.37 + 3462.60 + 3037.37 + 2664.36]

Discounted Payback Period

Remaining amount = 15000 – 13111.70 [initial Investment – amount recovered]

= $ 1883.30
1883.30 Remaining amount
Time required to recover the remaining amount = [ ]
2337.16 Discounted cash flow in year 5

= 0.81 years
Therefore, discounted payback period (Project P) = (4 + 0.81) years = 4.81 years
Payback Period (Project Q)
Year 1 Year 2 Year 3 Year 4 Year 5
Expected Cash Flows 11100 11100 11100 11100 11100
Discounted Cash Flows 9736.84 8541.09 7492.18 6572.09 5764.99

Amount recovered till year 3 = $ 33300 [11100 + 11100 + 11100]

Traditional Payback Period

Remaining amount = 37500 – 33300 [initial Investment – amount recovered]

= $ 4200
4200 Remaining amount
Time required to recover the remaining amount = [ ]
11100 Expected cash flow in year 4

= 0.38 years
Therefore, traditional payback period (Project Q) = (3 + 0.38) years = 3.38 years

Amount recovered till year 4 = $ 14859.92 [9736.84 + 8541.09 + 7492.18 + 6572.09]

Discounted Payback Period

Remaining amount = 37500 – 32342.20 [initial Investment – amount recovered]

= $ 5157.80
5157.80 Remaining amount
Time required to recover the remaining amount = [ ]
5764.99 Discounted cash flow in year 5

= 0.89 years
Therefore, discounted payback period (Project Q) = (4 + 0.89) years = 4.89 years
Payback Period of Problem 9-17 [for NPV of Problem 9-17, refer to Workings (April 7, 2020)]

Project Y Year 1 Year 2 Year 3 Year 4

Expected Cash Flows 10000 9000 7000 6000
Discounted Cash Flows 8771.93 6925.21 4724.80 3552.48

Amount recovered till year 2 = $ 19000 [10000 + 9000]

Traditional Payback Period

Remaining amount = 25000 – 19000 [initial Investment – amount recovered]

= $ 6000
6000 Remaining amount
Time required to recover the remaining amount = [ ]
7000 Expected cash flow in year 3

= 0.86 years
Therefore, traditional payback period (Project Y) = (2 + 0.86) years = 2.86 years

Amount recovered till year 4 = $ 23974.42 [8771.93 + 6925.21 + 4724.80 + 3552.48]

DPP

The initial investment of $ 25000 could not be recovered during project’s life (within 4 years).
Therefore, discounted payback period (Project Y) would require more than 4 years.
 Project Z Year 1 Year 2 Year 3 Year 4
Expected Cash Flows 0 0 0 36000
Discounted Cash Flows 0 0 0 21314.89

Amount recovered till year 3 = $ 0 [0 + 0 + 0]

Traditional Payback Period

Remaining amount = 25000 – 0 [initial Investment – amount recovered]

= $ 25000
25000 Remaining amount
Time required to recover the remaining amount = [ ]
36000 Expected cash flow in year 4

= 0.69 years
Therefore, traditional payback period (Project Z) = (3 + 0.69) years = 3.69 years

Amount recovered till year 4 = $ 21314.89 [0 + 0 + 0 + 21314.89]

DPP

The initial investment of $ 25000 could not be recovered during project’s life (within 4 years).
Therefore, discounted payback period (Project Z) would require more than 4 years.