FIN 300 Lecture Notes - Lecture 8: Payback Period, Cash Flow, Net Present Value

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mauvehound402

23 Nov 2016

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Npv (net present value): the difference between an investment"s market value and. Is a measure of how much value is value is created or added today by undertaking an investment its cost. Discounted cash flow (dcf) valuation: the process of valuing an investment by discounting its future cash flows. An investment should be accepted if the net present value is positive and rejected if it is negative. The payback is the length of time it takes to recover our initial investment. Payback period: the amount of time required for an investment to generate cash flows to recover its initial cost. Calculated by adding the future cash flows. Adjust for uncertainty of later cash flows. Disadvantages: ignores the time value of money requires an arbitrary cutoff point ignores cash flows beyond the cutoff point. Biased against lt projects, such as research and development and new projects ignores any risks associated with projects.

Related Questions

Which of the following statements are true? Select 4 that apply. (4 points)

Discounted payback method of capital appraisal ignores cash flows beyond the discounted payback period.

The net present value is found by discounting all positive cash flows at the projectâs cost of capital.

The project is accepted if the IRR is less than the projectâs cost of capital.

The IRR is the discount rate which forces the present value of a projectâs future cash flows to equal the future value of its costs.

Firms often choose among mutually exclusive projects on the basis of the present value of future costs.

To use the CAPM approach in capital budgeting, we estimate the firmâs beta, multiply this by the market risk premium and add the firmâs risk premium to the risk-free rate to obtain the firmâs cost of retained earnings or cost of equity.

The best proxy for the risk-free rate is the yield on treasury bonds.

Floatation costs are generally material when looking at its effect on the after-tax cost of debt.

burgundygnat457

The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft 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, Cute Camel'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 Year 1 Year 2 Year 3 $5,100,000 $2,100,000 $2,400,000 Expected cash flow 6,000,000 Cumulative cash flow Conventional payback period:

Year	Cash flow	Cumulative cash flow
0	-6,000,000
1	2,400,000
2	5,100,000
3	2,100,000

The conventional payback period ignores the time value of money, and this concerns Cute Camel's CFO. He has now asked you to compute Alpha's discounted payback period, assuming the company has a 7% 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 the nearest two decimal places. For full credit, complete the entire table.

Year	Discounted Cashflow	Cumulative discounted cash flow
1
2
3

beigetoad158

Cute Camel Woodcraft Company is a small firm, & several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Omegaâs expected future cash flows. To answer this question, Cute Camelâs CFO has asked that you compute the projectâs payback period using the following expected net cash flows & assuming that the cash flows are received evenly throughout each year. 1. Complete the following table & compute the projectâs conventional payback period. Year 0 Year 1 Year 2 Year 3 Expected cash flow $-5,000,000 $2,000,000 $4,250,000 $1,750,000 Cumulative cash flow $ $ $ $ Conventional payback period: The conventional payback period ignores the time value of money, & this concerns Cute Camelâs CFO. He has now asked you to compute Omegaâs discounted payback period, assuming the company has a 7% cost of capital. 2. Complete the following table & perform any necessary calculations. Round the discounted cash flow values to the nearest whole dollar, & the discounted payback period to the nearest two decimal places. Again, be sure to complete the entire table - even if the values exceed the point at which the cost of the project is recovered. Year 0 Year 1 Year 2 Year 3 Cash flow $-5,000,000 $2,000,000 $4,250,000 $1,750,000 Discounted cash flow Cumulative discounted cash flow Discounted payback period 3. Which version of a project's payback period should the CFO use when evaluating Project Omega, given its theoretical superiority? A. the discounted payback period B. the regular payback period 4. How much value does the discounted payback period method fail to recognize due to this theoretical deficiency? A. $3,297,680 B. $2,009,795 C. $5,140,636 D. $1,428,521

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FIN 300 Lecture Notes - Lecture 8: Payback Period, Cash Flow, Net Present Value

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