Question

Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta's expected future cash flows. To answer this question, Cold Goose's CFO has asked that you compute the project's payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project's conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Year o Year 1 Year 2 Year 3 Expected cash flow -$6,000,000 -$6,000,000 $2,400,000 -$3,600,000 $5,100,000 $1,500,000 $2,100,000 $3,600,000 Cumulative cash flow Conventional payback period: ars

Answer 1

2 Expected cash flow 3 Cumulative cash flow Year 0 (6,000,000) (6,000,000) Year 1 2,400,000 (3,600,000) Year 2 5,100,000 1,500,000 Year 3 2,100,000 3,600,000 5 Conventional payback period 1.7059 years 9 Expected cash flow 10 Discounted Cash flow 11 Cumulative cash flow 12 13 Conventional payback period Year o (6,000,000) (6,000,000) (6,000,000) Year 1 2,400,000 2,242,991 (3,757,009) Year 2 5,100,000 4,454,538 697,528 Year 3 2,100,000 1,714,226 2,411,754 1.8434 years 14 15 Given discounted payback takes time value of money into consideration, that is a superior 16 approach to regular payback 18 19 Discounted payback fails to recognize value 20 2,411,754

1 Year o Year 1 Year 2 Year 3 2 Expected cash flow 3 Cumulative cash flow -6000000 =B2 2400000 =B3+C2 5100000 =C3+D2 2100000 =D3+E2 5 Conventional payback period =1+(-C3/D2) years =C2 Year 3 =E2 =E9/(1+7%)^3 =D11+E10 7 Year 0 Year 1 Year 2 9 Expected cash flow =B2 =D2 10 Discounted Cash flow =B9/(1+7%)^0 =C9/(1+7%)^1 =D9/(1+7%)^2 11 Cumulative cash flow =B10 =B11+C10 =C11+D10 12 13 Conventional payback period =1+-C11/D10) years 14 15 16 Given discounted payback takes time value of money into consideration, that is a superior approach to regular payback 17 18 19 Discounted payback fails to recognize value =E11 20