The cash flows associated with an investment project are as follows:
Cash Flows
Initial Outflow -$70,000
Year 1 $20,000
Year 2 $30,000
Year 3 $30,000
Year 4 $30,000
If a firm uses discounted payback with a 15% discount rate and a 3-year cutoff period, what’s the discount payback period of the project? Should the firm accept the project?
Cumulative PV at end of year 3 = 20,000/1.15 +30,000/1.152 + 30,000/1.153 = 59,801
Cumulative PV at end of year 4 = 20,000/1.15 +30,000/1.152 + 30,000/1.153 + 30,000/1.154 = 76,954
By the end of year 4, the project produces a cumulative discounted cash flow of $76,954. Thus the project earns back the initial $70,000 at some point during the fourth year.
(70,000 - 59,801)/(76,954 - 59,801) = 0.6
The discount payback period is 3.6 years.