# FM11 41 - ≈ 0.4 into year 3 Therefore payback L = 2.4...

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j. 1. What is the payback period? Find the paybacks for franchises L and S. Answer: The payback period is the expected number of years required to recover a project's cost. We calculate the payback by developing the cumulative cash flows as shown below for project l (in thousands of dollars): Expected NCF Year Annual Cumulative 0 (\$100) (\$100) 1 10 (90) Payback is between t = 2 and t = 3 2 60 (30) 3 80 50 0 1 2 3 | | | | -100 10 60 80 -90 -30 +50 Franchise L's \$100 investment has not been recovered at the end of year 2, but it has been more than recovered by the end of year 3. Thus, the recovery period is between 2 and 3 years. If we assume that the cash flows occur evenly over the year, then the investment is recovered \$30/\$80 = 0.375
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Unformatted text preview: ≈ 0.4 into year 3. Therefore, payback L = 2.4 years. Similarly, payback S = 1.6 years. j. 2. What is the rationale for the payback method? According to the payback criterion, which franchise or franchises should be accepted if the firm's maximum acceptable payback is 2 years, and if franchises L and S are independent? If they are mutually exclusive? Answer: Payback represents a type of "breakeven" analysis : the payback period tells us when the project will break even in a cash flow sense. With a required payback of 2 years, franchise S is acceptable, but franchise L is not. Whether the two projects are independent or mutually exclusive makes no difference in this case. Mini Case: 11 - 41...
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