Question

Cold Goose Metal Works Inc. 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, Cold Goose'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. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Year 1 Year 3 Year o -$6,000,000 Year 2 $5,100,000 100.000 $2,400,000 $2,100,000 Expected cash flow Cumulative cash flow Conventional payback period: years The conventional payback period ignores the time value of money, and this concerns Cold Goose's CFO. He has now asked you to compute Delta's discounted payback period, assuming the company has a 7% 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 two decimal places. For full credit, complete the entire table. (Note: If your answer is negative, be sure to use a minus sign in your answer.) Year 0 -$6,000,000 Year 1 $2,400,000 Year 2 $5,100,000 Year 3 $2,100,000 Cash flow Discounted cash flow Cumulative discounted cash flow Discounted payback period: $ years Which version of a project's payback period should the CFO use when evaluating Project Delta, given its theoretical superiority? The regular payback period The discounted payback period

Answer 1

0 1 3 year -$6,000,000 $2,400,000 $5,100,000 $2,100,000 cash flows cumulative cash flows -6000000 -3600000 1500000 3600000 conventional payback period [1+(3600000/5100000) ] 1.71 years year -$6,000,000 $2,400,000 $5,100,000 $2,100,000 cash flows pv @7% 1 0.93458 0.87344 0.81630 |$4,454,537.51 $1,714, 225.54 $697,528.17 $2,411,753.71 -$6,000,000 $2,242,990.65 Discounted cash flow -$6,000,000 -$3,757,009.35 cumulative discounted cash flows 1.84 years [1+(3757009.35/4454537.51] discounted payback period Discounted payback period fail to recognise: discounted cash flows beyond discounted payback $2,411,755 4454537.51-3757009.35+1714225.54]