Question

**11. The NPV and payback period**

What information does the payback period provide?

A project’s payback period (PB) indicates the number of years required for a project to recover its initial investment using its operating cash flows. As the theoretical soundness of the conventional (undiscounted) PB technique was criticized, the model was modified to incorporate the time value of money-adjusted operating cash flows to create the discounted payback method. While both payback models continue to reflect faulty ranking criteria, they do provide important (useful) information regarding a project’s liquidity and riskiness.

In general, the **??????(LONGER?SHORTER** the
payback, other things constant, the greater the project’s
liquidity.

Suppose you are evaluating a project with the expected future cash inflows shown in the following table. Your boss has asked you to calculate the project’s net present value (NPV). You don’t know the project’s initial cost, but you do know the project’s regular, or conventional, payback period is 2.50 years.

Year |
Cash Flow |
---|---|

Year 1 | $300,000 |

Year 2 | 475,000 |

Year 3 | 475,000 |

Year 4 | 500,000 |

If the project’s weighted average cost of capital (WACC) is 10%, the project’s NPV (rounded to the nearest dollar) is:

$368,730

$333,612

$386,288

$351,171

Which of the following statements indicate a disadvantage of using the regular payback period (not the discounted payback period) for capital budgeting decisions? Check all that apply.

1) The payback period does not take the time value of money into account.

2) The payback period is calculated using net income instead of cash flows.

3) The payback period does not take the project’s entire life into account.

Answer #1

7. The NPV and payback
period
What information does the payback period
provide?
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
$325,000
Year 2
$500,000
Year 3
$450,000
Year 4
$450,000
If the project’s weighted average cost of capital (WACC) is 8%,
what is its NPV?
$367,583
$312,446
$404,341...

The NPV and payback period
Suppose you are evaluating a project with the cash inflows shown
in the following table. Your boss has asked you to calculate the
project’s net present value (NPV). You don’t know the project’s
initial cost, but you do know the project’s regular, or
conventional, payback period is 2.50 years.
The project's annual cash flows are:
Year
Cash Flow
Year 1
$400,000
Year 2
600,000
Year 3
500,000
Year 4
475,000
If the project’s desired rate...

Payback period essentially provides the number of years it would
take for a project to recover the initial investment from its
operating cash flows. As the model was criticized, the model
evolved incorporating time value of money to create the discounted
payback method. The models still reflected faulty ranking criteria
but they provided important information about liquidity and
risk.
Cash flows expected in the distant future are
more/less risky than cash flows received in the
near-term—which suggests that the payback...

Payback period essentially provides the number of years it would
take for a project to recover the initial investment from its
operating cash flows. As the model was criticized, the model
evolved incorporating time value of money to create the discounted
payback method. The models still reflected faulty ranking criteria
but they provided important information about liquidity and
risk.
Cash flows expected in the distant future aremore
risky than cash flows received in the near-term—which
suggests that the payback period...

What information does the payback period provide?
Suppose Praxis Corporation’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
$300,000
Year 2
$450,000
Year 3
$400,000
Year 4
$450,000
If the project’s weighted average cost of capital (WACC) is 10%,
what is its NPV?
A.) $302,510
B.) $332,761
C.) $317,636
D.) $287,385
Which...

7. The NPV and payback period
Suppose you are evaluating a project with the cash inflows shown
in the following table. Your boss has asked you to calculate the
project’s net present value (NPV). You don’t know the project’s
initial cost, but you do know the project’s regular, or
conventional, payback period is 2.50 years.
The project's annual cash flows are:
Year
Cash Flow
Year 1
$350,000
Year 2
600,000
Year 3
600,000
Year 4
450,000
If the project’s desired...

What information does the payback period provide?
Suppose you are evaluating a project with the expected future
cash inflows shown in the following table. Your boss has asked you
to calculate the project’s net present value (NPV). You don’t know
the project’s initial cost, but you do know the project’s regular,
or conventional, payback period is 2.50 years.
Year
Cash Flow
Year 1
$275,000
Year 2
$450,000
Year 3
$425,000
Year 4
$500,000
If the project’s weighted average cost of...

Suppose Acme Manufacturing Corporation’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
1
$325,000
2
$475,000
3
$500,000
4
$475,000
1. If the project’s weighted average cost of capital (WACC) is
9%, what is its NPV?
$314,973
$426,141
$389,085
$370,557
2. Which of the following statements indicate a disadvantage of
using the discounted payback...

Suppose Acme Manufacturing Corporation’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
$350,000
Year 2
$425,000
Year 3
$475,000
Year 4
$425,000
If the project’s weighted average cost of capital (WACC) is 7%,
what is its NPV?
$397,786
$437,565
$417,675
$457,454
Which of the following statements indicate a disadvantage of
using the...

Suppose you are evaluating a project with the cash inflows shown
in the following table. Your boss has asked you to calculate the
project’s net present value (NPV). You don’t know the project’s
initial cost, but you do know the project’s regular, or
conventional, payback period is 2.50 years.
The project's annual cash flows are:
Year
Cash Flow
Year 1
$375,000
Year 2
550,000
Year 3
400,000
Year 4
300,000
If the project’s desired rate of return is 9.00%, the...

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