Ch 11- Assignment - The Basics of Capital Budgeting

6. The payback period

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 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. (Note: Round the

conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.)

Expected cash flow

Cumulative cash flow

Conventional payback period:

Expected cash flow

Cumulative cash flow

Conventional payback period:

Year 0

-$4,500,000

Cash flow

Discounted cash flow

Cumulative discounted cash flow

Discounted payback period:

The conventional beback period ionores the time value of mones, and this concerns Cold Goose's CFO. He has now asked you to compute beta's

Ch 11- Assignment - The Basics of Capital Budgeting

Year

-$4,500,000

Year 1

$1,800,000

Year o

-$4,500,000

Year 1

$1,800,000

Year 2

$3,425,000

Year 1

$1,800,000

Year 2

$3,825,000

The conventional payback period ignores the time value of money, and this concerns Cold Goose's CFO. He has now asked you to compute Beta's

discounted payback period, assuming the company has a 5% cost of capital. Complete the following table and perform any necessary calculations.

Round the discounted cash flow values to the nearest whole dollar, and the discounted payback period to two decimal places. For full credit, complete

the entire table. (Note: If your answer is negative, be sure to use a minus sign in your answer.)

Year 3

$1,575,000

Year 2

$3,825,000

Year 3

$1,575,000

Year 3

$1,575,000

Which version of a project's perback period should the CFO use when evaluating Project Bets, given its theoretical superiority?

The regular payback period

O The discounted payback period