Question

In: Finance

The payback periodThe payback method helps firms establish and identify a maximumacceptable payback period...

The payback period

The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions.

Consider the case of Blue Hamster Manufacturing Inc.:

Blue Hamster Manufacturing Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Sigma’s expected future cash flows. To answer this question, Blue Hamster’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year.

Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to the nearest two decimal places. If your answer is negative use a minus sign.)

	Year 0	Year 1	Year 2	Year 3
Expected cash flow	-$4,000,000	$1,600,000	$3,400,000	$1,400,000
Cumulative cash flow
Conventional payback period:	........ years

The conventional payback period ignores the time value of money, and this concerns Blue Hamster’s CFO. He has now asked you to compute Sigma’s discounted payback period, assuming the company has a 7% cost of capital. Complete the following table and perform any necessary calculations. Round the discounted cash flow values to the nearest whole dollar, and the discounted payback period to the nearest two decimal places. For full credit, complete the entire table. (Note: If your answer is negative use a minus sign.)

	Year 0	Year 1	Year 2	Year 3
Cash flow	-$4,000,000	$1,600,000	$3,400,000	$1,400,000
Discounted cash flow
Cumulative discounted cash flow
Discounted payback period:	.......years

Which version of a project’s payback period should the CFO use when evaluating Project Sigma, given its theoretical superiority?

a.The regular payback period

b. The discounted payback period

One theoretical disadvantage of both payback methods—compared to the net present value method—is that they fail to consider the value of the cash flows beyond the point in time equal to the payback period.

How much value does the discounted payback period method fail to recognize due to this theoretical deficiency?

$2,638,144

$4,112,509

$1,607,836

$1,142,817

Expert Solution

jeff jeffy answered 2 years ago

The payback method helps firms establish and identify a maximum acceptable payback period that helps in...

The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta’s expected future cash flows. To answer this question, Cold Goose’s CFO has asked that you compute the project’s payback...

Briefly identify, in bullet point form, the strengths and weakness of each method: Payback period, ARR,...

Briefly identify, in bullet point form, the strengths and weakness of each method: Payback period, ARR, NPV, IRR. Then explain which method for evaluating capital project proposals do you favor the most, and why?

Question #5: Shortcliff Co.’s uses the Payback Period method for evaluating its projects. The Payback Period...

Question #5: Shortcliff Co.’s uses the Payback Period method for evaluating its projects. The Payback Period cut-off rule is 3 years. Shortcliff is considering the following project: Cash Flow for Year Project A 0 -$75,000 1 $33,000 2 $36,000 3 $19,000 4 $9,000 Required: Should Shortcliff accept or reject Project A? Why or why not?

The Basics of Capital Budgeting: Payback Period Payback Period Payback period was the earliest ________ selection...

The Basics of Capital Budgeting: Payback Period Payback Period Payback period was the earliest ________ selection criterion. -Select- capital structure financial statement capital budgeting The _________ -Select- NPV MIRR IRR payback 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 -Select- shorter longer a project's payback, the better the project is. However, payback has 3 main disadvantages: (1) All dollars received...

Distinguish between the payback period and the discounted payback period?

Payback Period

A project has an initial cost of $500,000 whereas it has an expected annual cash flow of $75,000 each year for the next 10 years. The firm has the criteria of accepting the project if its payback period is 6 years or less. Based on the payback period, state whether the project would be accepted or not?

What is the difference between discount payback period and payback period

3. Payback Period - Concerning payback: a. Describe how the payback period is calculated, and describe...

3. Payback Period - Concerning payback: a. Describe how the payback period is calculated, and describe the information this measure provides about a sequence of cash flows. What is the payback criterion decision rule? b. What are the problems associated with using the payback period to evaluate cash flows? c. What are the advantages of using the payback period to evaluate cash flows? Are there any circumstances under which using payback might be appropriate? Explain.

Which of the following is(are) the advantage(s) of the discounted payback period method comparing to the...

Which of the following is(are) the advantage(s) of the discounted payback period method comparing to the normal form of payback period method? (There may be more than one correct answer. You will lose marks by choosing a wrong answer. The minimum mark for the question is zero.) Select one or more: a. The discounted payback period method does not bias against long-term projects. b. The discounted payback period method considers all cash flows of a project. c. The discounted payback...

the longer the time period the less reliable the payback method. Is that a true statement?...

the longer the time period the less reliable the payback method. Is that a true statement? If so, why? Think about the time value of money. If we have a ten year time frame versus a three year time frame will the present value of an inflow in the latter years will be more or less accurate? In addition, think about how this relates to valuing a short versus long term debt security. With that said, honestly, are the more...