Question

Ch 11: Assignment - The Basics of Capital Budgeting Suppose ABC Telecom Inc.'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. Year Cash Flow Year 1 Year 2 Year 3 Year 4 $375,000 $475,000 $475,000 $500,000 If the project's weighted average cost of capital (WACC) is 8%, what is its NPV? $329,234 $370,389 $493,852 $411,543 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 time value of money into account The discounted payback period does not take the project's entire life into account. The discounted payback period is calculated using net income instead of cash flows.

Answer 1

1)

0.5 = Remaining amount / year 3 cash flow

Remaining amount = 0.5 * 475,000 = 237,500

Initial investment = 375,000 + 475,000 + 237,500 = 1,087,500

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1,087,500 + 375,000 / (1 + 0.08)¹ + 475,000 / (1 + 0.08)² + 475,000 / (1 + 0.08)³ + 500,000 / (1 + 0.08)⁴

NPV = $411,543

2)

The discounted payback period does not take the project's entire life into account

The discounted payback period does not take into account the cash flows received after the discounted payback period.