What information does the payback period provide? Suppose Omni Consumer Products

Question

What information does the payback period provide? Suppose Omni Consumer Products'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 weighted average cost of capital (WACC) is 10%, what is its NPV? Year Cash Flow Year 1 $300,000 Year 2 $500,000 Year 3 $400,000 Year 4 $425,000 O $318,271 O $290,595 O $262,919 O $276,757 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 is calculated using net income instead of cash flows. The discounted payback period does not take the time value of money into account. The discounted payback period does not take the project's entire life into account.

Explanation / Answer

payback period is number of years it takes to return initial investment

initial investment = 300000 + 500000 + 0.5 * 400000 = 1000000

NPV = -initial investment + Present value of cash flows

= -1000000 + 300000/(1+10%) + 500000/(1+10%)^2 + 400000/(1+10%)^3 + 425000/(1+10%)^4

= 276757

discounted payback does not take the projects entire life into account

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