You are CEO of Acme, Inc. located in the United States. You use the discounted payback period method and accept all projects that pay back in three years

You are considering a project that will cost $5,500,000 and will produce one cash flow that occurs in three years. However, the cash flow is in pesos since the project is an overseas project. The current indirect exchange rate is 13.5 pesos per dollar. The cash inflow in pesos is 100,000,000 in three years, and the discount rate is 11.5%. During this time, the anticipated annual inflation rate is 5% in the United States and 4% in Mexico. Should you accept this project, using the discounted payback period method? Is this a good decision?
What will be an ideal response?

Answer: First, we compute the forward exchange rate: 13.5 pesos per dollar × = 13.117948 pesos per dollar is the forward exchange rate.
Second, we convert all pesos into dollars using current and forward exchange rates:
= $7,623,143.78.
Third, we discount the dollar cash flow: = $5,499,326.55.
Fourth, we compare the $5,499,326.55 with the initial cost of $5,500,000. Since it falls short in paying back in three years, we REJECT the project.
Fifth, to consider if the decision is good, we compute the NPV: $5,499,326.55 - $5,500,000 = -$673.45.
Sixth, we apply the NPV decision rule and REJECT the project since the NPV < 0. Thus, the decision to reject based on discounted payback period method is a good decision, although the decision margin is very small in this case given the size of the project.