Question

You have just arrived at a SnappyPrints Inc., a maker of photo printers.  You are working in the Financial Planning department and have joined a team conducting capital budgeting analysis. Snappy is considering two new projects. Project Mini Printer (PMP) and Project High Speed Printer (HSP).  The WACC is 10%.  

                                   0                      1                      2                      3

                                   |                      |                      |                      |

Project PMP ($    -150                   40                   75                   100

Project PHS ($)   -150                   65                   75                    85

Answer the following questions:

14.  What is the payback period?  Find the discounted and regular paybacks for the Projects.

15.  What is the difference between the regular and discounted payback methods?

16.  What are the two main disadvantages of discounted payback?  Is the payback method useful in capital budgeting decisions?  Explain.

Upon further analysis, SnappyPrints believes that sales of the new High-Speed Printer would cannibalize the sales of its existing I-Phone Rapid Print Accessory by 50%, resulting in lost annual cash flow of $25.  

17. How can we define/what do we call this effect?
18. Should this effect be included in the cash flow projections?   
19. If so, which project should be accepted?  

Answer 1

Payback Period :

Payback period is the duration of time within which we recover the cost of our investment i.e., years it will take to get back the amount of investment.

A. Calculation of regular Payback period :

Payback Period = x + y/z

Where,

x= last year (period) with negative cash flow

y= cumulative value at the end of period x without any negative sign

z= cash inflow in the following period of x

Therefore,

For Project PMP :

2+35/100

=2.35 Years

For Project :

2+10/85

=2.12 Years

B. Calculation of Discounted Payback Period :

Discounted Payback Period = x+y/z

Where,

x= last year (period) with negative cash flow

y= discounted cumulative value at the end of period x without any negative sign

z= discounted cash inflow in the following period of x

Therefore,

Discounted Pyaback Period for Project PMP :

2+51.65/75.13

=2.69 Years

Discounted Payback Period for Project PHS :

2+28.93/63.86

=2.45 Years

• As we know that "Payback period is the duration of time within which we recover the cost of our investment i.e., years it will take to get back the amount of investment".In regular payback period calculation we calculate the duration without taking time value of money while in discounted payback period we calculate the duration after giving effect of time value of money to the cash flows.