Reference no: EM133275222
What information does the payback period provide?
A project's payback period (PB) indicates the number of years required for a project to recover its initial investment using its operating cash flows. As the theoretical soundness of the conventional (undiscounted) PB technique was criticized, the model was modified to incorporate the time value of money-adjusted operating cash flows to create the discounted payback method. While both payback models continue to reflect faulty ranking criteria, they do provide important (useful) information regarding a project's liquidity and riskiness.
In general, cash flows expected in the distant future are ______________ risky than cash flows received in the near-term-which suggests that the payback period can also serve as an indicator of project risk.
Suppose you are evaluating a project with the expected future cash inflows shown in the following table. Your boss has asked you to calculate the project's net present value (NPV). You don't know the project's initial cost, but you do know the project's regular, or conventional, payback period is 2.50 years.
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Year
|
Cash Flow
|
|
Year 1
|
$350,000
|
|
Year 2
|
475,000
|
|
Year 3
|
450,000
|
|
Year 4
|
425,000
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If the project's weighted average cost of capital (WACC) is 8%, the project's NPV (rounded to the nearest dollar) is:
a.$350,922
b. $298,284
c. $386,014
d.$315,830
Which of the following statements indicate a disadvantage of using the regular payback period (not the discounted payback period) for capital budgeting decisions? Check all that apply.
The payback period is calculated using net income instead of cash flows.
The payback period does not take the project's entire life into account.
The payback period does not take the time value of money into account.
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