Question

1.)

The conventional payback period ignores the time value of money, and this concerns Green Caterpillar’s CFO. He has now asked you to compute Alpha’s discounted payback period, assuming the company has a 9% cost of capital. Complete the following table and perform any necessary calculations. Round the discounted cash flow values to the nearest whole dollar, and the discounted payback period to two decimal places. For full credit, complete the entire table. (Note: If your answer is negative, be sure to use a minus sign in your answer.)

	Year 0	Year 1	Year 2	Year 3
Cash flow	-$4,500,000	$1,800,000	$3,825,000	$1,575,000
Discounted cash flow
Cumulative discounted cash flow
Discounted payback period:	years

2.)

How much value in this example does the discounted payback period method fail to recognize due to this theoretical deficiency?

$2,867,565

$1,216,189

$4,435,615

$1,586,991

Answer 1

A В C E F 7 Year 1 Year 3 Year 0 Year 2 9 Expected cash flow (4,500,000) 1,800,000 3,825,000 1,575,000 10 Discounted Cash flow (4,500,000) 1,651,376 3,219,426 1,216,189 11 Cumulative cash flow (4,500,000) (2,848,624) 1,586,991 370,802 12 13 Conventional payback period 1.8848 years 14 15 Given discounted payback takes time value of money into consideration, that is ior 16 approach to regular payback 17 18 19 Discounted payback fails to recognize value 1,586,991 20

A В E 7 8 Year 0 Year 1 Year 3 Year 2 9 Expected cash flow -4500000 1800000 3825000 1575000 =D9/(1+9% )A2 C11+ D10 -B9/(1+9%)^0 =C9/(1+9% )A1 -E9/(1+9%)A3 10 Discounted Cash flow 11 Cumulative cash flow B10 B11+C10 D11 + E10 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