Question

Suppose Extensive Enterprises’s CFO is evaluating a project with the following cash inflows. She does not know the project’s initial cost; however, she does know that the project’s regular payback period is 2.5 years.

Year	Cash Flow
Year 1	$275,000
Year 2	$450,000
Year 3	$500,000
Year 4	$400,000

If the project’s weighted average cost of capital (WACC) is 9%, what is its NPV?

A. $260,409

B. $390,613

C. $325,511

D. $309,235

Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply.

A. The discounted payback period does not take the project’s entire life into account.

B. The discounted payback period is calculated using net income instead of cash flows.

C. The discounted payback period does not take the time value of money into account.

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)ⁿ

Initial investment is computed as follows:

= $ 275,000 + 450,000 + 0.50 x $ 500,000

= $ 975,000

So, the NPV will be as follows:

= - $ 975,000 + $ 275,000 / 1.09 + $ 450,000 / 1.09²+ $ 500,000 / 1.09³ + $ 400,000 / 1.09⁴

= $ 325,511 Approximately

The discounted payback period does not take the project’s entire life into account indicates the disadvantage of discounted payback period

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