Payback period was the earliest selection criterion. The is a "break-even" calculation in the sense that...

Payback period was the earliest selection criterion. The is a "break-even" calculation in the sense that if a project's cash flows come in at the expected rate, the project will break even. The equation is: The a project's payback, the better the project is. However, payback has 3 main disadvantages: (1) All dollars received in different years are given weight. (2) Cash flows beyond the payback year are ignored. (3) The payback merely indicates when a project's investment will be recovered. There is no necessary relationship between a given payback and investor wealth maximization. A variant of the regular payback is the discounted payback. Unlike regular payback, the discounted payback considers costs. However, the discounted payback still disregards cash flows the payback year. In addition, there is no specific payback rule to justify project acceptance. Both methods provide information about and risk. 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 9%. 0 1 2 3 4 Project A -1,100 600 365 210 260 Project B -1,100 200 300 360 710 What is Project A's payback? Round your answer to four decimal places. Do not round your intermediate calculations. years What is Project A's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations. years What is Project B's payback? Round your answer to four decimal places. Do not round your intermediate calculations. years What is Project B's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations. years

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Expert Solution

The normal and discounted cashflows looks as per the below table.

	Project A	Project B
	Cashflows	Discounted @9%	Cashflows	Discounted @9%
Year0	-1100	-1100	-1100	-1100
Year1	600	550.46	200	183.49
Year2	365	307.21	300	252.50
Year3	210	162.16	360	277.99
Year4	260	184.19	710	502.98

For eaxample, Project Year1 discounted cashflow=600/1.09=550.46

Year3 discounted cashflow=210/1.09^3=162.16 and goes on like that

1. Payback period of A

They receives 965 in 2 years and have to receive the remaining 135 in 3rd year (1100-965=135)

in 3rd year=135/210=0.6429

In total, the payback period of A=2.6429 years

2. Discounted payback period of A

They receives 1019.83 in 3 years and have to receive the remaining 80.17 in 4th year (1100-1019.83=80.17)

in 4th year=80.17/184.19=0.4353

In total, the discounted payback period of A=3.4353 years

3. Payback period of B

They receives 860 in 3 years and have to receive the remaining 240 in 4th year (1100-860=240)

in 4th year=240/710=0.3380

In total, the payback period of B=3.3380 years

4. Discounted Payback period of B

They receives 713.98 in 3 years and have to receive the remaining 386.20 in 4th year (1100-713.98=386.02)

in 4th year=386.02/502.98=0.7675

In total, the discounted payback period of B=3.7675 years

jeff jeffy answered 1 year ago

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