Cute Camel Company is a small firm and several of its managers are worried about

Question

Cute Camel 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 Caramel's CFO has asked that you compute the projects payback period using the following expected net cash flows and assuming that the cash are received evenly throughout each year. Complete the following table and compute the project’s conventional payback period Year 0 Year 1 Year2 Year3 Expected Cash Flow -4,000,000 1,600,000 3,400,000 1,400,000 Culmulative Cash Flow ??? ??? ??? ??? Conventional Payback Period ??? The conventional payback period ignores the time value of money and this concerns Cute Caramel'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 Use the same cash flow table from above. Please show work. Which version of a project’s payback period should the CFO use when evaluating Project Delta, given its theoretical superiority? (the regular payback period or the discounted payback period)? One theoretical disadvantage of both payback methods compared to the net present value method is that they fail to consider the value of the cash flows beyond the point in time equal to the pay back period How much value does the discounted payback period method fail to recognize due to this theoretical deficiency? (1,607,836, 1,142,817, 4,112,509, 2,638,144)

Explanation / Answer

calculation of payback period ignores time value of money

   $ in 1000

so payback period is = 1 year +2400/3400

=1+0.7059

= 1.7059 years

calculation of discounted payback period $ in 1000

discounted payback period = 1+2504.67/2969.69

= 1.8434 years

net present value is 1,607,836

A is the correct option

year cash inflow/outflow cumilative cash flow 0 -4000 -4000 1 1600 -2400 2 3400 1000 3 1400 2400

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