Question

12. The payback period Aa Aa E The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta's expected future cash flows. To answer this question, Cute Camel's CFO has asked that you compute the project's payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project's conventional payback period. For full credit, complete the entire table. Year o -4,000,000 Year 1 $1,600,000 Year 2 $3,400,000 Year 3 $1,400,000 Expected cash flow Cumulative cash flow Conventional payback period: The conventional payback period ignores the time value of money, and this concerns Cute Camel's CFO. He has now asked you to compute Delta's discounted payback period, assuming the company has a 8% 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 o -4,000,000 Year 1 $1,600,000 Year 2 $3,400,000 Year 3 $1,400,000 Cash flow Discounted cash flow Cumulative discounted cash flow Discounted payback period:

Answer 1

O 1 2 year cash flows cumulative cash flows $4,000,000 -$4,000,000 $1,600,000 -$2,400,000 $3,400,000 $1,000,000 3 $1,400,000 $2,400,000 conventional payback period 1.71 years [ 1+2400000/3400000)] -$4,000,000 year cash flows pv @ 8% Discounted cash flow cumulative discounted cash flows 1 $1,600,000 0.925925926 $1,481,481 -$2,518,519 $3,400,000 0.85733882 $2,914,952 $396,433 $1,400,000 0.793832241 $1,111,365 $1,507,799 -$4,000,000 $4,000,000 discounted payback period 1.86 years 1+2518519/2914952) theoritical superiority: Discounted payback Discounted payback period fail to recognise: discounted cash flows beyond discounted payback $1,507,798 [ 2914952+1111365-2518519]