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CMA Final · Strategic Financial Management · Investment Decisions, Project Planning and Control

Ananya Foods is considering a project with an initial outlay of Rs 12,00,000 that will generate annual cash inflows of Rs 3,00,000 for 8 years. The company's cut-off discounted payback period is 5 years at a 10% cost of capital. Given the PV annuity factors at 10%: 5 years 3.791, 6 years 4.355, 8 years 5.335, what is the conclusion?

Reject the project. Simple payback is 4 years, but the present value of five years of inflows is only Rs 11,37,300, below the Rs 12,00,000 outlay, so discounted payback exceeds the 5-year cut-off.

  1. AAccept; simple payback is 4 years and discounted payback is within 5 years
  2. BReject; simple payback is 4 years but discounted payback exceeds 5 years since PV of 5 years inflows is Rs 11,37,300Correct
  3. CReject; PV of 8 years inflows is below the outlay
  4. DAccept; PV of 5 years inflows exceeds the outlay

Explanation

Simple payback = 12,00,000/3,00,000 = 4 years. PV of 5 years inflows = 3,00,000 x 3.791 = 11,37,300, which is less than 12,00,000, so the discounted payback exceeds 5 years (it is in year 6, PV 13,06,500). The project fails the cut-off even though simple payback looks good.

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