Following is table that shows the expected cash flows of a machine that QQQ Inc.
ID: 2667060 • Letter: F
Question
Following is table that shows the expected cash flows of a machine that QQQ Inc. is currently evaluating for possible purchase. Both the expected annual cash flows (CF) and the present values (PV) of the cash flows are shown in the table.Year Expected CF PV of CF Using the Firm's Required rate of return, r
0 $(10,000) $(10,000)
1 6,000 5,455
2 3,000 2,479
3 1,000 751
4 5,000 3,415
Compute both the traditional payback period and the discounted payback period.
Explanation / Answer
Traditional payback period is the period when sum of CFs equal to investment. (using CFs without discounting) Sum of cash flows = 6000 for year 1+3000 for year 2 + 1000 for year 3 = 10000 Hence tr. payback period = 3 (ANSWER) Discounted payback period is the period when sum of discounted CFs i.e. PVs is equal investment. (using DCFs i.e. PVs) Sum of PVs of cash flows = 5455 for year 1+ 2479 for year 2 + 751 for year 3 + (10000 - sum of 3 years)/2415 for year 4 = 10000 => 3years + part of 4th year i.e (10000 -8655)/2415 => 3.5569 years => 3 years, 6 months, 25 days approx. Hence tr. payback period = 3 years, 6 months, 25 days approx. (ANSWER)