Suppose Your Firm Is Considering Investing in a Project with the Cash

question 52

Multiple Choice

Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and three and a half years, respectively. Use the payback decision to evaluate this project; should it be accepted or rejected? $$\begin{array} { | l | l | l | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 & 6 \\\hline \begin{array} { l } \text { Cash } \\\text { Flow }\end{array} & - 85,000 & \$ 12,000 & \$ 11,000 & \$ 13,000 & \$ 21,000 & \$ 31,000 & \$ 32,000 \\\hline\end{array}$$

• A)Payback = 4.90 years; reject
• B)Payback = 4.40 years; reject
• C)Payback = 5.80 years; reject
• D)Payback > 6.00 years; reject

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Definitions:

Maintenance Margin

The minimum amount of capital that must be maintained in a margin account after a purchase or trade, to cover the risk of loss.

Margin Call

A requirement from a broker for an investor to add more cash or securities to their account to mitigate potential losses.

Short 100 Shares

The action of borrowing 100 shares of a stock to sell them with the expectation of buying them back later at a lower price.

Margin Call

A request from a broker to an investor to add more funds or securities to compensate for potential losses.