Please answer the following fill in the blank and multiple choice entriely. Than
ID: 2792705 • Letter: P
Question
Please answer the following fill in the blank and multiple choice entriely. Thanks!
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 period using the following expected net cash flows and assuming that the cash flows are receidevenly throughout each year Complete the following table and compute the project's conventional payback period. For full credit, complete the ntire table. Year 0 Year 1 Year 2 Year 3 Expected cash flow Cumulative cash flow -6,000,000 $2,400,000 $5,100,000 $2,100,000 Conventional payback period: The conventional payback period ignores the time value of money, and this concerns Cold Goose's CFO. He has now asked you to compute Delta's discounted payback period, assuming the company has a 10% cost of capital. Complete the followigtand 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 ntire table Year 0 Year 1 Year 2 Year 3 Cash flow Discounted cash flow Cumulative discounted cash flow -6,000,000 $2,400,000 $5,100,000 $2,100,000 Discounted payback period Which version of a project's payback period should the CFO use when evaluating Project Delta, given its theoretical superiority? O The regular payback period O 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? O $3,759,579 O $1,974,455 O $5,792,637 O $1,577,761Explanation / Answer
Payback period is the time it takes for a project to return the initial capital, Payback period is different than discounted payback in which cash flows are discounted first with required rate of return/discount rate, in payback period method cash flows are not discounted.
Year
Cash Inflow
Cumulative cash flow
1
2400000
2400000
2
5100000
7500000
3
2100000
9600000
Payback period will fall between year 1 and 2
Payback period will be,
= 1+ (6000000 - 2400000)/5100000
= 1+ (3600000)/ 5100000
= 1+ 0.71
= 1.71 years
While calculating payback Cash flow from asset/project first discounted using required rate of return then payback period is calculated. Discounted payback is the time it takes for a project to return the initial cost.
If the required rate of return is 0.09
Payback period will be,
Year
Cash Inflow
Present value factor
Present value of cash flow
Cumulative cash flow
1
2400000
0.90909
2181818.182
2181818
2
5100000
0.82645
4214876.033
6396694
3
2100000
0.75131
1577761.082
7974455
Payback period will fall between year 1 and 2
Payback period will be calculated following way,
= 1+ (6000000 - 2181818.18181818)/ 4214876.03305785
= 1+ (3818181.81818182)/ 4214876.03305785
= 1+ 0.91
= 1.91 YEARS.
.
Discounted PAYBACK IS USED.
Year
Cash Inflow
Cumulative cash flow
1
2400000
2400000
2
5100000
7500000
3
2100000
9600000
Payback period will fall between year 1 and 2
Payback period will be,
= 1+ (6000000 - 2400000)/5100000
= 1+ (3600000)/ 5100000
= 1+ 0.71
= 1.71 years