Question

“Bankrupt” Corporation is in a deep financial crisis. You are one of the financial avengers “Bankrupt” is desperately seeking help from. CEO of the company informed you that he is considering the two risky projects “Thanos” and “Loki” to protect the firm from financial collapse. Both projects have similar risk characteristics. Bankrupt’s WACC is 11%. The initial investments for both the projects are $200 million. Cashflow from the projects are as follows;

Year           1                2                3                4

Thanos       10M           60M           80M           160M

Loki           70M           50M           20M           160M

Now, your job is to explain the following questions in great detail so that the CEO understands your plans to protect the firm.

1. Calculate the pay-back and discounted pay-back for both the project. Discuss the differences between the two methods.

Answer 1

		Cash flow		Cumulative cash flow		PVIF @ 11%	Present value		Cumulative present value
	Year	Thanos	Loki	Thanos	Loki		Thanos	Loki	Thanos	Loki
	0	-200	-200	-200	-200	1	(200.00)	(200.00)	(200.00)	(200.00)
	1	10	70	-190	-130	0.900901	9.01	63.06	(190.99)	(136.94)
	2	60	50	-130	-80	0.811622	48.70	40.58	(142.29)	(96.36)
	3	80	20	-50	-60	0.731191	58.50	14.62	(83.80)	(81.73)
	4	160	160	110	100	0.658731	105.40	105.40	21.60	23.66
Computation of payback period
		Thanos	3+50/160	3.31	year
		Loki	3+60/160	3.38	year
Computation of discounted payback period
		Thanos	3+83.8/105.4	3.80	year
		Loki	3+81.73/105.4	3.78	year
	Difference between payback and discounted payback period is that discounted payback period consider the time value of money
	but payback period does not consider the time value of money. Discounted payback period is improvement of payback period method.