The conventional payback period ignores the time value of money, and this concer

Question

The conventional payback period ignores the time value of money, and this concerns Blue Hamster's CFO. He has now asked to compute Alpha's discounted payback period,assuming the company has a 9% cost of capital. complete the table.

Year 0 Year 1 Year 2 Year 3

Cash flow -5000000 2,000,000 4,250,000 1,750,000

Discounted cash flow ? ? ? ?

Cumulated discounted cash flow ? ? ? ?

Discounted payback period ?

How mch value does the discounted payback period method fail to recognize due to this theoretical deficiency?

Explanation / Answer

Where,
   A = Last period with a negative discounted cumulative cash flow;
   B = Absolute value of discounted cumulative cash flow at the end of the period A;
   C = Discounted cash flow during the period after A.

= 1+ (-2903795) / 3281779 = 1.88 years

The discounted payback period method fail to recognize due to this theoretical deficiency because it ignores cash flows after its payback period.

Year Cash flow Present Value Factor Discounted Cash Flow
CF×PV$1 Cumulative Discounted PV$1=1/(1+i)n Cash Flow a b c=a*b Year 0 -5000000 0.917 -4587155.96 -4587155.96 Year 1 2000000 0.842 1683359.99 -2903795.98 Year 2 4250000 0.772 3281779.79 377983.81 Year 3 1750000 0.708 1239744.12 1617727.93

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