Question

hat information does the payback period provide?

Suppose Omni Consumer Products’s CFO is evaluating a project with the following cash inflows. She does not know the project’s initial cost; however, she does know that the project’s regular payback period is 2.5 years.

Year	Cash Flow
Year 1	$350,000
Year 2	$400,000
Year 3	$425,000
Year 4	$475,000

If the project’s weighted average cost of capital (WACC) is 7%, what is its NPV?

$507,936

$465,608

$423,280

$338,624

Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply.

The discounted payback period does not take the time value of money into account.

The discounted payback period is calculated using net income instead of cash flows.

The discounted payback period does not take the project’s entire life into account.

Answer 1

- Project's Regular payback Period = 2.5 years

Payback period measn that by how much time does the Project recover's its Initial Investment from its Annual cash flows. As Payback period is 2.5 years which lies between year 2 and 3.

Initial Investmment = Year 1 Cashflow + Year 2 Cashflow + Year 3 Cashflow*(2.5 years - 2 years)

Initial Investmment = $350,000 + $400,000 + $425,000*0.5

Initial Investmment = 962,500

ii). Calculating the Project's NPV using WACC as 7%:-

Year	Cash Flow of Project ($)	PV Factor @7%	Present Value of Project ($)
0	(962,500.00)	1.00000	(962,500.000)
1	350,000.00	0.93458	327,102.804
2	400,000.00	0.87344	349,375.491
3	425,000.00	0.81630	346,926.598
4	475,000.00	0.76290	362,375.226
			423,280.12

So, NPV of the Project is $423,280

Option 3

iii). Disadvantage of using Discounted payback Period:-

Ans- option 3. The discounted payback period does not take the project’s entire life into account.

Discounted payback Period ignores the whole life of project as it only calculate the no of years till it recovers the Initial Investment.

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