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 8%.

	0		1		2		3		4
Project A	-1,200		700		450		290		340
Project B	-1,200		300		385		440		790

What is Project A's payback? Round your answer to four decimal places. Do not round intermediate calculations.

_____ years

What is Project A's discounted payback? Round your answer to four decimal places. Do not round intermediate calculations.

______ years

What is Project B's payback? Round your answer to four decimal places. Do not round intermediate calculations.

______ years

What is Project B's discounted payback? Round your answer to four decimal places. Do not round intermediate calculations.

______ years

Answer 1

Project A Payback Period calculation:

Year 1: Initial Investment + year 1 cashflow = -1200 + 700 = -500

Year 2: Year 1 Payback + Year 2 cashflow = -500 + 450 = -50

Year 3: Year 2 payback + year 3 cashflow = -50 + 290 = 240

Project A	Years	Cashflow	Payback
	0	-1200
	1	700	-500
	2	450	-50
	3	290	240
	4	340

So, we see that the payback turns positive between year 2 and year 3.

Payback period = Year 2 Payback/Year 3 cashfow = 2 + (50/290) = 2.17 years

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Project A Discounted Payback Period calculation:

For this, we calculate the present values of each cashflow first.

PV = Cashflow/(1+ discount rate)^time where Discount Rate =WACC =8%

WACC	8%
Project A	Years	Cashflow	PV	Discounted Payback
	0	-1200	-1200
	1	700	648.15	-551.85
	2	450	385.80	-166.05
	3	290	230.21	64.16
	4	340	249.91

Year 1: Initial Investment + year 1 PV = -1200 + 648.15 = -551.85

Year 2: Year 1 Payback + Year 2 PV = -551.85 + 385.80 = -166.05

Year 3: Year 2 payback + year 3 PV = -166.05 + 230.21 = 64.16

So, discounted payback is achieved between year 2 and year 3 = 2 + (166.05/230.21) = 2.72 years

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Project B Payback Period calculation:

Year 1: Initial Investment + year 1 cashflow = -1200 + =300 = -900

Year 2: Year 1 Payback + Year 2 cashflow = -900 + 385 = -515

Year 3: Year 2 payback + year 3 cashflow = -515 + 440 = -75

Year 4: Year 3 payback + year 4 cashflow = -75 + 790 = 715

Project B	Years	Cashflow	Payback
	0	-1200
	1	300	-900.00
	2	385	-515.00
	3	440	-75.00
	4	790	715.00

Payback period is achieved in the year 3 and year 4 = 3 + (75/790) = 3.09 years

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Project B Discounted Payback Period calculation:

For this, we calculate the present values of each cashflow first.

PV = Cashflow/(1+ discount rate)^time where Discount Rate =WACC =8%

WACC	8%
Project B	Years	Cashflow	PV	Discounted Payback
	0	-1200	-1200
	1	300	277.78	-922.22
	2	385	330.08	-592.15
	3	440	349.29	-242.86
	4	790	580.67	337.81

The discounted payback is achieved between year 3 and year 4.

So, Discounted Payback = 3 + (242.86/580.67) = 3.42 years