Payback Period Payback period was the earlies break even. The equation is: selec

Question

Payback Period Payback period was the earlies break even. The equation is: selection criterion. The -Selectis a "break-even" calculation in the sense that if a project's cash flows come in at the expected rate, the project will Number of Payback - years prior to + Unrecovered coet at start of year Casb Dow during full recovery year full recovery The Select- a project's payback the better the project is. However, payback has 3 main disadvantages: 1) All dollars received in different years are given select weight 2) Cash flows beyond the payback year are ignored. (3) The payback merely indicates when a project's investment will be recovered. There is no necessary relationship between a given payback and investor wealth maximization. A variant the regular payback is the discounted payback. Unlike regular payback the discounted payback considers select costs. However, the discounted payback still disregards cash flows Select- | the payback year. In addition, there is no specific payback rule to justify project acceptance. Both methods provide information about I -Select- | and risk. Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 7%. Project A-900 Project 900 375 310 260 410 310 760 600 200 What is Project A's payback? Round your answer to four decimal places. Do not round your intermediate calculations. years What is Project A's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations. years What is Project B's payback? Round your answer to four decimal places. Do not round your intermediate calculations years What is Project B's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations. ears

Explanation / Answer

Payback period is the no. of years it takes to recover the initial investment of $900 in this case.

For Project A, we can see that we recover the investment in year 2 itself.

Payback period = 1 + (900 - 600) / 375 = 1.8000 years

For Project B, Payback Period = 2 + (900 - 200 - 310) / 410 = 2.9512 years

For discounted cash flows, first calculate discounted cash flows (DCF) = CFn / (1 + r)^n, where, r = 6%

For A, Discounted Payback Period = 2 + (900 - 561 - 328) / 212 = 2.0552 years

For B, Discounted Payback Period = 3 + (900 - 187 - 271 - 335) / 580 = 3.1856 years

Year CF A CF B DCF A DCF B 0 -900 -900 -900 -900 1 600 200 561 187 2 375 310 328 271 3 260 410 212 335 4 310 760 236 580 Payback 1.8000 2.9512 2.0552 3.1856

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.