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

Sundaram Textiles is evaluating a machine costing Rs 8,00,000 with no salvage value. It is expected to generate equal annual net cash inflows of Rs 2,00,000 for 6 years. The firm's required payback period is 3.5 years. Which statement is correct?

Payback equals the initial outlay divided by the equal annual inflow, which is 8,00,000 divided by 2,00,000, or 4 years. Since this is longer than the 3.5-year required period, the project is rejected under the payback criterion.

  1. APayback period is 4 years, so the project is rejected under the payback criterionCorrect
  2. BPayback period is 3 years, so the project is accepted
  3. CPayback period is 4 years, so the project is accepted
  4. DPayback period is 6 years, so the project is rejected

Explanation

Payback = 8,00,000 / 2,00,000 = 4 years. This exceeds the 3.5-year cut-off, so the project is rejected under the payback criterion. Accepting it would require wrongly ignoring the cut-off, and 3 years results from an arithmetic slip.

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