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um CUCK HERE TO ACCESS ? X y MindTap . Cengage lean ?-> cle secure l https://ng 5% MIN DTAP c/nb/ui/evo/index.htmi?dep ploy 5516511817006901338045010198 Feum Cengage Assignment 11 - The Basics of Capital Budgeting 8. The NPV and payback period Aa Aa What information does the payback period provide? Suppose you are evaluating a project with the expected future cash inflows shown in the folowing table. Your boss has asked you to calculate the project\'s net present value (NPV). You dont know the project\'s initial cost, but you do know the project\'s regular, or conventional, payback period is 2.50 years If the project\'s ~WACC-in, the project\'s NPV (rounded to the nearest dollar) is: Year Cash Flow Year 1 $350,000 Year 2 $425,000 Year 3 $400,000 Year 4 $425,000 O $374,064 O $355,361 O$299,251 0 %392,767 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 time value of money into account. ? The payback period does not take the project\'s entire life into account. OSHIBA

Solution

Payback Period gives us an idea that how long it will take for a project to recover the initial investment.

The regular payback period is 2.5 years means it will take 2.5 years for a project to recover the initial investment and cash flow of 2.5 years of project equals to

= Cash flow of year 1+ Cash flow of year 2 + (Cash flow of year 3)/2

= $350,000 + $425,000 + $400,000/2

= $350,000 + $425,000 + $200,000

=$975,000

Therefore the initial investment of the project is $975,000

Net present value (NPV) compares the value of a dollar today of a project to the value of that same dollar in the future. NPV is used in capital budgeting method to assess the profitability of a project.

Net present value (NPV) of project = [Expected cash flow/ (1+ Discount rate) ^n] – Initial investment

Required rate of return or WACC = 7%, therefore Net present value (NPV) is

NPV = $350,000/ (1+7%) ^1+ $425,000/ (1+7%) ^2 + $400,000/ (1+7%) ^3 + $425,000/ (1+7%) ^4 - $975,000

NPV = $327,102.80 + $371,211.46 + $326,519.15 + $324,230.47 -$975,000

NPV = $374,063.88 or $374,064

Therefore correct answer is option $374,064.

The disadvantage of using regular payback period for capital budgeting decision is the payback period does not take the time value of money into account as it is not discounted to present value.

Therefore correct answer is option: The payback period does not take the time value of money into account