7. The payback period Aa Aa The payback method helps fims establish and identify

Question

7. The payback period Aa Aa The payback method helps fims establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Fuzzy Button Clothing Company: Fuzzy Button Clothing Company 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 Alpha's expected future cash flows. To answer this question, Fuzzy Button'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. Year 0 Year 1 Year 2 Year 3 6,000,000 $2,400,000 $5,100,000 $,100,000 Expected cash flow Cumulative cash flow Conventional payback period:

Explanation / Answer

Cumulative cash flows

Year 0: -6000000

Year 1: -6000000+2400000=-3600000

Year 2: -3600000+5100000=1500000

As year 1 is the last year where cumulative cash flows is negative

so payback=1+3600000/5100000=1.706 years

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