Blue Hamster Manufacturing Inc. is a small firm, and several of its managers are

Question

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 Alpha'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 Year O Year 1 Year 2 Year 3 Expected cash flow Cumulative cash flow -5,500,000 $2,200,000 $4,675,000 $1,925,000 Conventional payback peri iod The conventional payback period ignores the time value of money, and this concerns Blue Hamster's CFO. He has now asked you to compute Alpha's discounted payback period, assuming the company has a 10% 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 Year O Year 1 Year 2 Year 3 Cash flow Discounted cash flow Cumulative discounted cash flow -5,500,000 $2,200,000 $4,675,000 $1,925,000 Discounted payback period

Explanation / Answer

Cumulative Cash flow at year 0: -5500000
Cumulative Cash flow at year 1: -5500000+2200000=-3300000
Cumulative Cash flow at year 2: -3300000+4675000=1375000

Conventional payback=1+3300000/46750000=1.070588 years

Discounted cash flow in year 0: -5500000
Cumulative discounted Cash flow at year 0: -5500000
Discounted cash flow in year 1: 2200000/1.1=2000000
Cumulative Cash flow at year 1: -5500000+2000000=-3500000
Discounted cash flow in year 2: 4675000/1.1^2=3863636
Cumulative Cash flow at year 2: -3500000+3863636=363636

Disscounted payback=1+3500000/3863636=1.905882 years

Discounted pyaback is superior and it should be used

Unrecognized Portion of Discounted cash flow in year 2:3863636*(2-1.905882)=363637.7
Discounted cash flow in year 3: 1925000/1.1^3=1446281

Total unrecognized value=1809917

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