Question

Assignment 11 - The Basics of Capital Budgeting Back to Assignment Attempts: Average: 14 Attention: Due to a bug in Google Chrome, this page may not function correcty. Click here to learn more. 8. 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. If the project's weighted average cost of capital (WACC) is 8%, what is its NPV? Year Cash Flow Year 1 $300,000 Year 2 $425,000 Year 3 $425,000 Year 4 $500,000 O $409.540 O $450,494 O $327,632 $348,109 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 does not take the project's entire life into account. The discounted payback period does not take the time value of money into account. The discounted payback period is calculated using net income instead of cash flows.

Answer 1

Initial investment= $300,000 + $425,000 + $425,000/2

                                  = $300,000 + $425,000 + $212,500

                                  = $937,500.

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$937,500. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the weighted average cost of capital of 8%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 8% the weighted average cost of capital is $409,540.40.

Hence, the answer is option a.

A disadvantage of using discounted payback period in capital budgeting decisions is that the discounted payback period does not take the project’s entire life into account.

Hence, the answer is option a.

In case of any query, kindly comment on the solution.