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 11%.

0 1 2 3 4

ProjectA -1,150 650 415 280 330

Project B -1,150 250 350 430 780

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

Answer 1

Project A Payback period

Step 1: calculate cumulative present values

Step 2: find out the year in which initial investment is recovered

Project A

Year	Cash Inflows	Cumulative Cash flows
1	650	-
2	415	1065
3	280	1345
4	330	1675

Initial investment for Project A = 1,150

1065 dollars can be collected in the second year and the remaining (1150-1065) 85 should be collected from the third year. So the exact payback period is calculated using the interpolation method.

= 2 years + (85/280) = 2.3035 years

Project A : Discounted Payback period

Step 1 calculate the present value of future cash inflows

Step 2: calculate cumulative present values

Step 3: find out the year in which initial investment is recovered

Present value of future cash inflows = Future cash inflows * Present value factor

Year	Cash Inflows	Present Value Factor	Calculation	Cumulative cash flows
1	650	0.901	585.65	--
2	415	0.812	336.98	922.63
3	280	0.731	204.68	1127.31
4	330	0.659	217.47	1344.78

Initial investment for Project A = 1,150

1127.31 dollars can be collected in the third year and the remaining (1150-1127.31) 22.69 should be collected from the fourth year. So the exact payback period is calculated using the interpolation method as,

= 3 years + (22.69/217.47) = 3.10434 years

Project B: Payback Period

Year	Cash Inflows	Cumulative Cash flows
1	250
2	350	600
3	430	1030
4	780	1810

Initial investment for Project B= 1,150

1030 dollars can be collected in the second year and the remaining (1150-1030) 120 should be collected from the third year. So the exact payback period is calculated using the interpolation method.

= 3 years + (120/780) = 3.1538 years