Question

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What information does the payback period provide? Suppose Extensive Enterprises'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 7%, what is its NPV? Year Year 1 Year 2 Year 3 Year 4 Cash Flow $300,000 $400,000 $450,000 $500,000 O $476,208 O $362,825 $544,237 O $453,531 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 is calculated using net income instead of cash flows. The discounted payback period does not take the time value of money into account.

Answer 1

1:453531

2: Option 1

Since payback is 2.5 years

Initial cost = CF1+CF2+0.5*CF3 = 300000+400000+0.5*450000

=925000

NPV= C0+ CF1/(1+r)^1 + CF2/(1+r)^2 …………CFn/(1+r)^n

=-925000+300000/1.07^1+400000/1.07^2+450000/1.07^3+500000/1.07^4

=453531

Option 1: The discounted payback will only consider the cash flows till the time the initial outlay is recovered.

Option 2 and 3 are not true. The discounted payback considers cash flows and takes into account the discounted cash flows.