Question

Gem E. Fallon LLP (GEF) is currently evaluating an investment in a new comedy club. The club is expected to last for 4 years and generate a CF1 = $11,000, CF2 = $9,680, CF3 = $10,648, and CF4 = $58,564. The initial outlay is $20,000. Using a required return of 10%, calculate the discounted payback period for GEF's comedy club. (All answers below are expressed in years.)

		(a) 2.19
		(b) 2.25
		(c) 2.00
		(d) 1.93
		(e) 3.00

Answer 1

Year	cash flow [A]	Discount factor [B]	Discounted cash flow [A*B]	Cummulative discounted cash flow
0	-20000	1	-20000	-20000
1	11000	.90909	9999.99	-10000.01      [-20000+9999.99]
2	9680	.82645	8000.04	-1999.97    [-10000.01+8000.04]
3	10648	.75131	7999.95	5999.98    [-1999.97+7999.95]
4	58564	.68301	39999.80	45999.78     [5999.98+39999.98]

**Discount factoris calculating using the formula 1/(1+i)^n or can be find from the present value table at 10% for 1,2,3,4

Discounted payback period = Year up to which cummulative discounted cash flow is negative +[ discounted cummulative cash flow of that period /discounted cash flow of next year]

         = 2+ [1999.97/7999.95]

        = 2 + .25

          = 2.25 years

correct option is " b"