Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is

Question

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 Beta'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 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 0 6,000,000 $6,000,000 Year 1 Year 2 Year 3 Expected cash flow Cumulative cash flow $2,400,000 $5,100,000 $2,100,000 Conventional payback period:

Explanation / Answer

A) Conventional payback period:

Cumulative cash flows:

Year 0: -6000000

Year 1: -6000000+2400000 = -3600000

Year2: -3600000+5100000 = 1500000

Year 3: 1500000+2100000 = 3600000

Conventional Payback period = 1 + 3600000/5100000 = 1.71 years

B) Discounted Payback method:

Discounted cash flow:

Year 0= -6000000

Year 1: 2400000/1.08 = 2222222.22

Year 2: 5100000/1.08^2 = 4372427.98

Year 3: 2100000/1.08^3 = 1667047.71

Cumulative cash flows:

Year 0 = -6000000

Year 1: -6000000+2222222.22 = -3777777.78

Year 2: -3777777.78+4372427.98 = 549650.2

Year 3: 549650.2+1667047.71 = 2216697.91

Discounted Payback period = 1+3777777.78/4372427.98

= 1.86 years

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