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

Sundaram Auto Ltd is evaluating a machine costing Rs 10,00,000 that will earn net cash inflows of Rs 3,00,000 per year for 6 years, with no salvage value. The firm uses a cut-off payback period of 3.5 years. What is the payback period, and what is the decision under the payback criterion?

Payback is Rs 10,00,000 divided by Rs 3,00,000, which equals 3.33 years. This is below the 3.5-year cut-off, so the project is accepted under the payback criterion. The decision rule accepts projects recovering the investment within the maximum acceptable period.

  1. A3.33 years; accept the projectCorrect
  2. B3.33 years; reject the project
  3. C4.00 years; reject the project
  4. D2.50 years; accept the project

Explanation

Payback = 10,00,000 / 3,00,000 = 3.33 years because the inflows are uniform. Since 3.33 is less than the cut-off of 3.5 years, the project is accepted. Option C wrongly uses a different divisor, and option B reverses the decision.

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