Suppose ABC Telecom Inc.?s CFO is evaluating a project with the following cash i

Question

Suppose ABC Telecom Inc.?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. If the project?s WACC is 7%, what is its NPV? Year Cash Flow $352,447 Year 1 $325,000 $391,608 Year 2 $450,000 $430,769 $450 349 Year 3 $400,000 Year 4 $450,000 Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply. The discounted payback period does not take the project?s entire life into account. The discounted payback period is calculated using net income instead of cash flows. The discounted payback period does not take the time value of money into account.

Explanation / Answer

Projects regular payback period is 2.5 years i.e. 2years and 6 months

Therefore, Projeact initial cost would be inflow of Year 1 + Year 2 + Half of Year 3

i.e. = 325000 + 450000 + (400000/2)

Therefore project initial cost = $975000

Calculating PV of cash inflow

Year 1 - 325000 *0.93458 = $303738.3178

Year 2 - 450000 *0.87344 = $393047.4277

Year 3 - 400000 *0.816298 = $326519.1508

Year 4 - 450000 *0.7629 = $343302.8454

Total Cash inflow = $1366607.7417

NPV = $1366607.7417 - $975000 = $391607.7417 i.e. $391608

B)

Of the following the first statement indicate a disadvantage of using discounted payback period

i.e. The discounted payback period does not take the projects entire life into account

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