Question

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 Year 1 Year 2 Year 0 Year 3 Expected cash flow -5,500,000 $2,200,000 $4,675,000 $1,925,000 Cumulative cash flow Conventional payback period: The conventional payback period ignores the time value of money, and this concerns Fuzzy Button'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 the nearest two decimal places. For full credit, complete the entire table. Year 0 Year 1 Year 2 Year 3 $4,675,000 Cash flow 5,500,000 $2,200,000 $1,925,000 Discounted cash flow Cumulative discounted cash flow Discounted payback period: Which version of a project's payback period should the CFO use when evaluating Project Alpha, given its theoretical superiority? O The regular payback period The discounted payback period One theoretical disadvantage of both payback methods-compared to the net present value method-is that they fail to consider the value of the cash flows beyond the point in time equal to the payback period. How much value does the discounted payback period method fail to recognize due to this theoretical deficiency? $1,939,656 O $3,504,802 $5,421,307 $1,486,453

Answer 1

Solution :

The Conventional payback period = 1.71 years

The Discounted payback period = 1.88 years

The CFO while evaluating its project should follow the Discounted Payback method due to its theoretical superiority.

The value that the discounted payback period fails to recognize due to its theoretical deficiency is = $ 1,939,656

which is the Net Present value of the Project.

Please find the attached screenshots of the excel sheets containing the detailed calculation for the solution.

26.11.2019 - Microsoft Excel ES FILE HOME A B PAGE LAYOUT FORMULAS DATA REVIEW VIEW INSERT C Statement showing calculation of Cumulative cash flows Sl.No. Year Expected Cash Flow Cumulative cash flow $ -5,500,000.00 $ -5,500,000.00 $ 2,200,000.00 $ -3,300,000.00 $ 4,675,000.00 $ 1,375,000.00 1,925,000.00 $ 3,300,000.00 Statement showing calculation of Conventional Payback period of the project SI.No.Year Expected Cash Flow Cumulative cash flow 2,200,000.00 $ 2,200,000.00 4,675,000.00 $ 6,875,000.00 1,925,000.00 $ 8,800,000.00 Conventional Payback Period: The Conventional Payback period lies between the year 1 & 2 as the Initial Investment of $5,500,000 is earned during the year 2 Hence Conventional Payback period = 1 year +[($ 5,500,000 - $2,200,000) / $ 4,675,000 ] = 1+[ 3,300,000 / 4,675,000 ] = 1 +0.7059 = 1.7059 years; = 1.71 years (when rounded off to two decimal places)

26.11.2019 - Microsoft Excel XES FILE HOME A B FORMULAS DATA REVIEW VIEW INSERT C PAGE LAYOUT D Sl.No. Year |(2) Statement showing calculation of Cumulative Discounted cash flow PV Factor @ 9% Expected Cash Flow Discounted Cash flow Cumulative (3)=(1)*(2) Discounted Cash flow 1.0000 $ -5,500,000.00 $ -5,500,000.00 $ -5,500,000.00 0.9174 $ 2,200,000.00 $ 2,018,348.62 $ -3,481,651.38 0.8417 $ 4,675,000.00 $ 3,934,853.97 $ 453,202.59 0.7722 $ 1,925,000.00 $ 1,486,453.20 $ 1,939,655.79 (2) Statement showing calculation of Discounted Payback period of the project PV Factor @9% Expected Cash Flow Discounted Cash flow Cumulative (1) (3)=(1)*(2) Discounted Cash flow 0.9174 $ 2,200,000.00 $ 2,018,348.62 $ 2,018,348.62 0.8417 $ 4,675,000.00 $ 3,934,853.97 $ 5,953,202.59 0.7722 $ 1,925,000.00 $ 1,486,453.20 $ 7,439,655.79 Discounted Payback period: The Discounted Payback period lies between the year 1 & 2 as the initial Investment of $5,500,000 is earned during the year 2 Hence Discounted Payback period = 1 year +[($ 5,500,000 - $ 2,018,348.62)/$ 3,934,853.97] = 1 + [3,481,651.38 / 3,934,853.97 ] = 1 +0.8848 = 1.8848 years; = 1.88 years (when rounded off to two decimal places)

26.11.2019 - Microsoft Excel X FILE 5 HOME в INSERT PAGE LAYOUT FORMULAS DATA REVIEW VIEW А Statement showing calculation of Net Present Value Sl.No. Particulars Cash Flow PVF @ 9% Discounted cash Flows 1 Cash Inflow Year 1 $ 2,200,000.00 0.9174 $ 2,018,348.62 2 Cash Inflow Year 2 $ 4,675,000.00 0.8417 $ 3,934,853.97 3 Cash Inflow Year 3 $ 1,925,000.00 0.7722 $ 1,486,453.20 Total of Discounted Cash Inflows - (A) 7,439,655.79 Less : Initial Investment - (B) $ 5,500,000.00 Net Present value = (A) - (B) 1,939,655.79 Net Present value (Rounded off to the nearest whole number) $ 1,939,656