Question

7. The NPV and payback period What information does the payback period provide? Suppose Omni Consumer Products'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 Year 1 Year 2 Year 3 Year 4 Cash Flow $350,000 $400,000 $500,000 $450,000 If the project's weighted average cost of capital (WACC) is 9%, what is its NPV? $362,656 $290,125 $435,187 $326,390 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

NPV = PV of cash Inflows - PV of cash Outflows

Paybac period 2.5 Years means Initial investment is CF in 2 Years + [ 0.5 * Cf of Year 3 ]

= 350000 + 400000 + [ 0.5 * 500000 ]

= 350000 + 400000 + 250000

= 1000000

NPV = PV of cash Inflows - PV of cash Outflows

Year	CF	PVF @9%	Disc CF
0	$ -10,00,000.00	1.0000	$ -10,00,000.00
1	$     3,50,000.00	0.9174	$     3,21,100.92
2	$     4,00,000.00	0.8417	$     3,36,672.00
3	$     5,00,000.00	0.7722	$     3,86,091.74
4	$     4,50,000.00	0.7084	$     3,18,791.34
NPV			$    3,62,656.00

option A is correct.

Part B:

Discounted Payback period is the Period in which initial investment is recovered after considering the time value of money.

Thus it considers Cash Flows and Time Value of Money.

However it doesn't consider full life of Project.

Option C is correct