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Roxxon Co. wants to know how long it will take project Alpha to pay back its orginal investment. Project Alpha's expected net cash flows are shown as follows:

Year 0 = -$600,000

Year 1 = 325,000

Year 2 = 375,000

Year 3 = 450,000

The CFO wants to know project Alpha's payback period. In order to include the time value of money, we want to know the project's discounted payback period.

Assuming that annual cash flows are received evenly throughout the year and the project's WACC is 10% what is the:

Regular payback period?

Discounted payback period?

Is the regular payback method or the discounted payback period ethod better when evaluating project Alpha?

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Nelly Stracke
Nelly StrackeLv2
28 Sep 2019

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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    

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 Omega’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 & assuming that the cash flows are received evenly throughout each year. 1. Complete the following table & compute the project’s 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 Camel’s CFO. He has now asked you to compute Omega’s 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

1. Which of the following is true?
The corporation model can be used to value divisions and firms that do not pay dividends.
The discounted dividend model can be used to value divisions and firms that do not pay dividends.
For the discounted dividend model, a firm's weighted average cost of capital is used as the discount rate.
For the corporate valuation model, a firm's cost of equity is used as the discount rate.
Question 2.2. Which of the following is false?
For the constant growth model to hold, a firm's cost of equity needs to be smaller than its constant dividend growth rate (i.e., rs < g).
For the constant growth model to hold, a firm's cost of equity needs to be greater than its constant dividend growth rate (i.e., rs > g).
From the constant growth model, if the constant dividend growth rate is equal to zero, a firm's share price is equal to the constant dividend divided by the cost of equity (i.e., g=0).
If a company's constant dividend growth rate is negative, the formula for the constant growth model cannot be applied.
Question 3.3. From the discussion of a firm's capital budgeting problem in chapter 11, which of the following is false? (Points : 3.5)
The net present value method (NPV) assumes that cash flows are reinvested at the weighted average cost of capital (WACC).
The internal rate of return method (IRR) assumes that cash flows are reinvested at the internal rate of return.
The modified internal rate of return method (MIRR) assumes that cash flows are reinvested at the weighted average cost of cpaital.
For mutually exclusive projects, if there is a conflict between NPV and IRR, the project with the highest IRR is chosen.
The IRR is independent of a firm's weighted average cost of capital.
Question 4.4. Which of the following is true? (
As a firm's dividend payout ratio increases, the firm's WACC decreases.
The WACC only represents the "hurdle rate" for a typical project with average risk. Therefore, the project's WACC should be adjusted to reflect the project's risk.
Firms with riskier projects generally have a lower WACC.
Holding all else constant, an increase in the target debt ratio tends to lower the WACC.
Question 5.5. Which of the following is false?
If interest rates rise, the price of the bond will rise and its YTM (yield to maturity) will fall.
Short-term bond prices are less sensitive than long-term bond prices to interest rate changes.
Companies are not likely to call bonds unless interest rates have declined significantly. Thus, the call provision is valuable to firms but detrimental to long term investors.
On balance, bonds that have a sinking fund are regarded as being safer than those without such a provision.
Question 6.6. Which of the following is not true? (Points : 3.5)
According to SML (security market line), the risk premium on a high-beta stock would increase more than that on a low-beta stock.
If beta < 1.0, the security is less risky than average.
According to the Security Market Line (SML), in general, a company’s expected return will double when its beta doubles.
According to the Security Market Line (SML), if a portfolio of real world stocks has a beta of zero, the required rate of return for the portfolio is equal to the risk-free rate.
Question 7.7. P&G Industries bonds have a maturity of 15 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 10 years at $1,125, and currently sell at a price of $1,105. What is their nominal annual yield to call?
6.87%.
7.37%.
11.05%.
8.32%.
Question 8.8. Which of the following is not the flaw (weakness) of the discounted payback method? (Points : 3.5)
It does not tells us by how much the project should increase shareholder wealth, or by how much a project yields over the cost of capital; it merely tells us when we recover our investment.
It ignores cash flows occurring after the payback period.
It ignores the time value of money, that is, dollars received in different years are all given the same weight.
Question 9.9. Jermey Lin has $52,500 invested a stock with a beta of 0.80 and another $47,500 invested in a stock with a beta of 3.2. If these are the only two investments in his portfolio, what is his portfolio's beta?
1.56.
1.82.
2.00.
1.94
Question 10.10. According to CAPM, if the required rate of the return of Stock A obtained from the security market line (SML) is less than the expected rate of the return of stock A from the capital market transaction, then stock A is
fairly priced.
undervalued.
overvalued.
Question 11.11. Determine the yield-to-call (to nearest 0.1 of a percent) of an LTV bond with a 12 percent coupon, that pays interest annually. The bond can be called in 5 years, has a call premium of $114, and is currently selling for $912.50. The bond has a face value of $1,000.
14.58%.
13.92%.
16.34%.
12.17%.
Question 12.12. Project M costs $1,000, its expected cash inflows are $500 per year for 3 years, and its WACC is 11%. What is the project's NPV? (Points : 3.5)
$259.57.
$221.86.
$195.23.
$257.35.
Question 13.13. Project J costs $1,025, its expected cash inflows are $425 per year for 3 years, and its WACC is 10%. What is the project's IRR?
12.58%.
10.82%.
11.76%.
9.64%.
Question 14.14. Project X costs $6,750, its expected cash inflows are $1250 per year for 10 years, and its WACC is 10%. What is the project's payback?(Note, the regular payback is asked in this question, not the discounted payback.) (Points : 3.5)
5.40 years.
10 years.
4.58 years.
6.12 years.
Question 15.15. Project S costs $800, its expected cash inflows are $350 per year for 3 years, and its WACC is 7%. What is the project's MIRR?
13.97%.
12.04%.
14.93%.
9.15%.
Question 16.16. Project Y costs $650, its expected cash inflows are $500 per year for 5 years, and its WACC is 10%. What is the project's discounted payback?
1.47 years.
1.24 years.
1.62 years.
1.15 years.
1. Which of the following is true?
The corporation model can be used to value divisions and firms that do not pay dividends.
The discounted dividend model can be used to value divisions and firms that do not pay dividends.
For the discounted dividend model, a firm's weighted average cost of capital is used as the discount rate.
For the corporate valuation model, a firm's cost of equity is used as the discount rate.
Question 2.2. Which of the following is false?
For the constant growth model to hold, a firm's cost of equity needs to be smaller than its constant dividend growth rate (i.e., rs < g).
For the constant growth model to hold, a firm's cost of equity needs to be greater than its constant dividend growth rate (i.e., rs > g).
From the constant growth model, if the constant dividend growth rate is equal to zero, a firm's share price is equal to the constant dividend divided by the cost of equity (i.e., g=0).
If a company's constant dividend growth rate is negative, the formula for the constant growth model cannot be applied.
Question 3.3. From the discussion of a firm's capital budgeting problem in chapter 11, which of the following is false?
The net present value method (NPV) assumes that cash flows are reinvested at the weighted average cost of capital (WACC).
The internal rate of return method (IRR) assumes that cash flows are reinvested at the internal rate of return.
The modified internal rate of return method (MIRR) assumes that cash flows are reinvested at the weighted average cost of cpaital.
For mutually exclusive projects, if there is a conflict between NPV and IRR, the project with the highest IRR is chosen.
The IRR is independent of a firm's weighted average cost of capital.
Question 4.4. Which of the following is true? (Points : 3.5)
As a firm's dividend payout ratio increases, the firm's WACC decreases.
The WACC only represents the "hurdle rate" for a typical project with average risk. Therefore, the project's WACC should be adjusted to reflect the project's risk.
Firms with riskier projects generally have a lower WACC.
Holding all else constant, an increase in the target debt ratio tends to lower the WACC.
Question 5.5. Which of the following is false? (Points : 3.5)
If interest rates rise, the price of the bond will rise and its YTM (yield to maturity) will fall.
Short-term bond prices are less sensitive than long-term bond prices to interest rate changes.
Companies are not likely to call bonds unless interest rates have declined significantly. Thus, the call provision is valuable to firms but detrimental to long term investors.
On balance, bonds that have a sinking fund are regarded as being safer than those without such a provision.
Question 6.6. Which of the following is not true? (Points : 3.5)
According to SML (security market line), the risk premium on a high-beta stock would increase more than that on a low-beta stock.
If beta < 1.0, the security is less risky than average.
According to the Security Market Line (SML), in general, a company’s expected return will double when its beta doubles.
According to the Security Market Line (SML), if a portfolio of real world stocks has a beta of zero, the required rate of return for the portfolio is equal to the risk-free rate.
Question 7.7. P&G Industries bonds have a maturity of 15 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 10 years at $1,125, and currently sell at a price of $1,105. What is their nominal annual yield to call? (Points : 3.5)
6.87%.
7.37%.
11.05%.
8.32%.
Question 8.8. Which of the following is not the flaw (weakness) of the discounted payback method? (Points : 3.5)
It does not tells us by how much the project should increase shareholder wealth, or by how much a project yields over the cost of capital; it merely tells us when we recover our investment.
It ignores cash flows occurring after the payback period.
It ignores the time value of money, that is, dollars received in different years are all given the same weight.
Question 9.9. Jermey Lin has $52,500 invested a stock with a beta of 0.80 and another $47,500 invested in a stock with a beta of 3.2. If these are the only two investments in his portfolio, what is his portfolio's beta? (Points : 3.5)
1.56.
1.82.
2.00.
1.94
Question 10.10. According to CAPM, if the required rate of the return of Stock A obtained from the security market line (SML) is less than the expected rate of the return of stock A from the capital market transaction, then stock A is (
fairly priced.
undervalued.
overvalued.
Question 11.11. Determine the yield-to-call (to nearest 0.1 of a percent) of an LTV bond with a 12 percent coupon, that pays interest annually. The bond can be called in 5 years, has a call premium of $114, and is currently selling for $912.50. The bond has a face value of $1,000. (Points : 3.5)
14.58%.
13.92%.
16.34%.
12.17%.
Question 12.12. Project M costs $1,000, its expected cash inflows are $500 per year for 3 years, and its WACC is 11%. What is the project's NPV?
$259.57.
$221.86.
$195.23.
$257.35.
Question 13.13. Project J costs $1,025, its expected cash inflows are $425 per year for 3 years, and its WACC is 10%. What is the project's IRR? (
12.58%.
10.82%.
11.76%.
9.64%.
Question 14.14. Project X costs $6,750, its expected cash inflows are $1250 per year for 10 years, and its WACC is 10%. What is the project's payback?(Note, the regular payback is asked in this question, not the discounted payback.) (Points : 3.5)
5.40 years.
10 years.
4.58 years.
6.12 years.
Question 15.15. Project S costs $800, its expected cash inflows are $350 per year for 3 years, and its WACC is 7%. What is the project's MIRR? (
13.97%.
12.04%.
14.93%.
9.15%.
Question 16.16. Project Y costs $650, its expected cash inflows are $500 per year for 5 years, and its WACC is 10%. What is the project's discounted payback?
1.47 years.
1.24 years.
1.62 years.
1.15 years.

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