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.
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.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text: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.)
Year 0
Year 1
Year 2
Year 3
Expected cash flow
-$4,500,000
$1,800,000
$3,825,000
$1,575,000
Cumulative cash flow
2$
2$
24
Conventional payback period:
years
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 8% 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.)
Transcribed Image Text:Year 0
Year 1
Year 2
Year 3
Cash flow
-$4,500,000
$1,800,000
$3,825,000
$1,575,000
Discounted cash flow
2$
2$
Cumulative discounted cash flow
24
24
Discounted payback period:
years
Which version of a project's payback period should the CFO use when evaluating Project Beta, given its theoretical superiority?
The discounted payback period
The regular payback period
One theoretical disadvantage of both payback methods-compared to the net present value method-is that they fail to consider the value of the cash
flows beyond the point in time equal to the payback period.
How much value in this example does the discounted payback period method fail to recognize due to this theoretical deficiency?
$4,529,607
$1,696,274
$1,250,286
$2,916,953
Expert Solution
Step 1
To determine the conventional cash flows we will determine the cumulative cash flows and see when the cumulative cash flows are becoming positive.
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