Question

5. The NPV and payback period

What information does the payback period provide?

Suppose Acme Manufacturing Corporation’s CFO is evaluating a project with the following cash inflows. She does not know the project’s initial cost; however, she does know that the project’s regular payback period is 2.5 years.

Year	Cash Flow
Year 1	$300,000
Year 2	$475,000
Year 3	$425,000
Year 4	$450,000

If the project’s weighted average cost of capital (WACC) is 7%, what is its NPV?

$318,390

$437,786

$457,685

$397,987

Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply.

The discounted payback period is calculated using net income instead of cash flows.

The discounted payback period does not take the time value of money into account.

The discounted payback period does not take the project’s entire life into account.

Answer 1

Payback period provides period in which investement will return back.
Using Pay back period,
Project's Initial Investment = 300000+475,000+(425000/2)
Project's Initial Investment = $987,500
Net Present value
Year	Cash flows	Discount factor at 7%	Discounted cash flows
Year 0	-987500	1.000000	-987500
Year 1	300000	0.934579	280374
Year 2	475000	0.873439	414883
Year 3	425000	0.816298	346927
Year 4	450000	0.762895	343303
NPV			397987
Disadvantages of using the discounted payback period
The discounted payback period does not take the project’s entire life into account.