Question

The payback method helps firms establish and identify a maximum acceptable payback period that helps in capital budgeting decisions. There are two versions of the payback method: the conventional payback method and the discounted payback method. Consider the following case: Fuzzy Button Clothing Company 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, Fuzzy Button'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. Round the payback period to the nearest two decimal places. Be sure to complete the entire table-even if the values exceed the point at which the cost of the project is recovered. Year o Year 1 Year 2 $3,825,000 Year 3 $1,575,000 Expected cash flow $1,800,000 $-4,500,000 -4500000 Cumulative cash flow Conventional payback period: 1.71 years

Answer 1

Year 0 1 Cash flow Cumulative cash flow (4,500,000.00) (4,500,000.00) 1,800,000.00 (2,700,000.00) 3,825,000.00 1,125,000.00 1,575,000.00 2,700,000.00 1.71 3

Year Cash flow P.V.Factor Discounted C.F Cumulative cash flows (4,500,000.00) (4,500,000) (4,500,000) 1,800,000.00 0.925925926 1,666,667 (2,833,333) 21 3,825,000.00 0.85733882 3,279,321 445,988 1,575,000.00 0.793832241 1,250,286 1,696,273 1.86 WIN

Discounted payback period