What information does the payback period provide? Suppose Praxis Corporation’s CFO is evaluating a project with...

What information does the payback period provide?

Suppose Praxis Corporation’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	$325,000
Year 2	$400,000
Year 3	$500,000
Year 4	$400,000

If the project’s weighted average cost of capital (WACC) is 10%, what is its NPV?

a. $239,917

b. $284,901

c. $299,896

d. $329,886

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

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

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

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

Solutions

Expert Solution

Ans1) c. 299896

Ans 2) 1. The discounted payback period does not take the time value of money into account.

Year	Project Cash Flows (i)	DF@ 10%	DF@ 10% (ii)	PV of Project ( (i) * (ii) )
0	-975000	1	1	(9,75,000)
1	325000	1/((1+10%)^1)	0.909091	2,95,455
2	400000	1/((1+10%)^2)	0.826446	3,30,579
3	500000	1/((1+10%)^3)	0.751315	3,75,657
4	400000	1/((1+10%)^4)	0.683013	2,73,205
		NPV	2,99,896

	Cash Outflow =	Year 1 + Year 2 + 0.5 * Year 3
		325000 + 400000 + 0.5 * 500000
		975000

jeff jeffy answered 1 year ago

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