Question

Suppose you are evaluating a project with the expected future cash inflows shown in the following table. Your boss has asked you to calculate the project's net present value (NPV). You don't know the project's initial cost, but you do know the project's regular, or conventional, payback period is 2.50 years. Year Cash Flow Year 1 $300,000 Year 2 $450,000 Year 3 $400,000 Year 4 $450,000 If the project's weighted average cost of capital (WACC) is 7%, the project's NPV (rounded to the nearest dollar) is: $334,257 O $393,243 O $471,892 O $432,567 Which of the following statements indicate a disadvantage of using the regular payback period (not the discounted payback period) for capital budgeting decisions? Check all that apply. The payback period is calculated using net income instead of cash flows. The payback period does not take the time value of money into account. The payback period does not take the project's entire life into account.

Answer 1

Payback Period = 2.50 years

Sum of Cash flows of 1 to 2 years = $300,000 + $450,000

= $750,000

0.50 portion of Cash flow in year 3 = $400,000*0.5

= $200,000

Total cash flow in Payback Period = $750,000 + $200,000

= $950,000

So, the Initial Cash Outflow is $950,000

Now, Calculating the NPV of the Project:-

Year	Cash Flows of Project ($ )	PV Factor @7%	Present Value of Project ($)
0	(950,000.00)	1.0000	(950,000.00)
1	300,000.00	0.9346	280,373.83
2	450,000.00	0.8734	393,047.43
3	400,000.00	0.8163	326,519.15
4	450,000.00	0.7629	343,302.85
			393,243.26

So, NPV of the Project is $393,243.26

Option 2

- Ans - Option 2 & 3

The major Disadvantage of Payback period is it does not consider Time value of money, ie., does not dicount cash flow. While other is it does not take into consideration Project's entire life into account.