Question

Fuzzy Button Clothing 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 Omega's expected future cash flows. To answer this question, Fuzzy Button'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. Year 0 -4,500,000 Year 1 $1,800,000 Year 2 $3,825,000 Year 3 $1,575,000 Expected cash flow Cumulative cash flow Conventional payback period: The conventional payback period ignores the time value of money, and this concerns Fuzzy Button's CFO. He has now asked you to compute Omega's discounted payback period, assuming the company has a 9% 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.

Answer 1

Project Simple payback Project Discounted payback Discounted Cumulative Year Cashflows Cumulative cashflow Cashflows PVIF@9% cash flow discounted cashflow 0 $(4,500,000) $ (4,500,000) $ (4,500,000)| 1.000 $ (4,500,000) $ (4,500,000) 1 $ 180,000 $ (4,320,000) $ 180,000 0.917 $ 165,138 $ (4,334,862) 2 $ 3,825,000 $ (495,000) $ 3,825,000 0.842 $ 3,219,426 $ (1,115,436) 3 $ 1,575,000 $ 1,080,000 $ 1,575,000 0.772 $1,216,189 $ 100,753 Conventional payb 2.31 Years =2+495000/1575000 Discounted payback 2.92 Years =2+1115436/1216189 The discounted payback has theoritical superiority as it considers time value of money. Discounted payback method failed to recognise $ 100,753

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