Suppose Extensive Enterprises\'s CFO is evaluating a project with the following

Question

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 10%, what is its NPV? Year Cash Flow Year1 $375,000 Year 2 $400,000 Year 3 $475,000 Year 4 $400,000 O $289,068 O $260,161 $317,975 O $332,428 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 is calculated using net income instead of cash flows. The discounted payback period does not take the project's entire life into account. The discounted payback period does not take the time value of money into account.

Explanation / Answer

The major disadvantage of using discounted payback period as capital budgeting is that it does not take into consideration the time value of money of the cash flows which is a major flaw for an investor to take decision based on this.

It is correct to say that reinvestment rate assumption in MIRR is more realistic as in IRR the reinvestment is done at IRR itself. Managers are not slow to adopt IRR as it is easy to understand.

Sophisticated firms generally use all 5 measures in capital budgeting decisions. These measures are : NPV, IRR, payback period, discounted payback period and MIRR)

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