Question

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%. 0 1 2 3 4 Project A -950 650 385 270 320 Project B -950 250 320 420 770 What is Project A's payback? Round your answer to four decimal places. Do not round your intermediate calculations. years Hide Feedback Partially Correct Check My Work Feedback What is Project A's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations. years Hide Feedback Incorrect Check My Work Feedback What is Project B's payback? Round your answer to four decimal places. Do not round your intermediate calculations. years Hide Feedback Incorrect Check My Work Feedback What is Project B's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations. years Hide Feedback Incorrect Check My Work Feedback

Answer 1

Payback period is the period in which the oinitial investment is recovered.

a) Project A's payback

Investment = $950

Amount recovered in year 1 = $650

Amount recovered in year 2 = $385

Total amount recovered in 2 years = $1035

So, the payback period is between 1 and 2 years.

Payback period = 1 + (950-650)/385 = 1.7792 years

b) Project A's discounted payback

Discounted Year 1 cash flow = 650/1.07 = $607.4766

Discounted Year 2 cash flow = 385/1.07² = $336.2739

Discounted Year 3 cash flow = 270/1.07³ = $220.4004

Amount recovered in 2 years = $943.7505

Discounted Payback period = 2 + (950-943.7505)/220.4004 = 2.0284 years

c) Project B's payback

Payback period = 2 + (950-250-320)/420 = 2.9048 years

d) Project B's discounted payback

Discounted Year 1 cash flow = 250/1.07 = $233.6448

Discounted Year 2 cash flow = 320/1.07² = $279.5004

Discounted Year 3 cash flow = 420/1.07³ = $342.8451

Discounted Year 4 cash flow = 770/1.07⁴ = $587.4293

Discounted Payback period = 3 + (950-233.6448-279.5004-342.8451)/587.4293 = 3.1600 years