Question

12. The NPV and payback period Suppose you are evaluating a project with the 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. The project's annual cash flows are:

Year Cash Flow

Year 1 $375,000

Year 2 400,000

Year 3 300,000

Year 4 475,000

If the project’s desired rate of return is 8.00%, the project’s NPV—rounded to the nearest whole dollar—is . ($281,958/ $299,580/ $317,202/ $352,447)

Which of the following statements indicates a disadvantage of using the regular, or conventional, 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 into account the time value of money effects of a project’s cash flows.

The payback period does not take into account the cash flows produced over a project’s entire life.

Answer 1

1.Initial cash flow= $375,000 + $400,000 + $300,000/2

= $375,000 + $400,000 + 150,000

   =925,000.

Net present value is calculated using a financial calculator by inputting the below:

• •   Press the CF button.
• •   CF0= -$925,000. It is entered with a negative sign since it is a cash outflow.
• •   Cash flow for each year should be entered.
• •   Press Enter and down arrow after inputting each cash flow.
• •   After entering the last cash flow cash flow, press the NPV button and enter the desired rate of return is 8%.
• •   Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows of the project is $352,446.60 $\rightarrow$ $352,447.

2.   A disadvantage of the regular payback period is that it does not take the time value of money effects of a project’s cash flow into account.

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