Question

Cute Camel Woodcraft Company is a small firm, & several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Omega’s expected future cash flows. To answer this question, Cute Camel’s CFO has asked that you compute the project’s payback period using the following expected net cash flows & assuming that the cash flows are received evenly throughout each year. 1.

Complete the following table & compute the project’s conventional payback period.

Year 0 Year 1 Year 2 Year 3

Expected cash flow $-5,000,000 $2,000,000 $4,250,000 $1,750,000

Cumulative cash flow $ $ $ $ Conventional payback period:

The conventional payback period ignores the time value of money, & this concerns Cute Camel’s CFO. He has now asked you to compute Omega’s discounted payback period, assuming the company has a 10% cost of capital.

2. Complete the following table & perform any necessary calculations. Round the discounted cash flow values to the nearest whole dollar, & the discounted payback period to the nearest two decimal places. Again, be sure to complete the entire table - even if the values exceed the point at which the cost of the project is recovered.

Year 0 Year 1 Year 2 Year 3

Cash flow $-5,000,000 $2,000,000 $4,250,000 $1,750,000

Discounted cash flow Cumulative discounted cash flow Discounted payback period:

3. Which version of a project's payback period should the CFO use when evaluating Project Omega, given its theoretical superiority?

A. the discounted payback period

B. the regular payback period

4. How much value does the discounted payback period method fail to recognize due to this theoretical deficiency?

Answer 1

Answer no. 1

Particulars	Year 0	Year 1	Year 2	Year 3
Expected Cash Flow	(5,000,000)	2,000,000	4,250,000	1,750,000
Cumulative Cash Flow	(5,000,000)	(3,000,000)	1,250,000	3,000,000
Payback Period	1 year + 3000000/4250000 =1.71 year

Answer no. 2

Particulars	Year 0	Year 1	Year 2	Year 3
Cash Flow	-5000000	2000000	4250000	1750000
Present value factor @ 10%	1	0.90909	0.82644	0.75131
Discounted cash flow	(5,000,000)	1,818,180	3,512,370	1,314,801
Cumulative Discounted Cash Flow	(5,000,000)	(3,181,820)	330,550	1,645,351
Discounted Payback period	1 year + 3,181,820/3,512,370= 1.91 years

Answer no. 3

B. Discounted payback period

Because it consider the time value of money and discounting cash flow at required rate of return.

Answer no. 4

value fails to recognised due to theoretical deficiency = Discounted cash flow after payback period =1645351