Capital Budgeting Decision Criteria Payback Payback Was The Earliest Capital Budgeting Selection Criterion The Paybac 1 (147.38 KiB) Viewed 10 times
Capital Budgeting Decision Criteria Payback Payback Was The Earliest Capital Budgeting Selection Criterion The Paybac 2 (157.44 KiB) Viewed 10 times
Capital Budgeting Decision Criteria: Payback Payback was the earliest capital budgeting ✓selection criterion. The payback is a "break-even" calculation in the sense that if a project's cash flows come in at the expected rate, the project will break even. The equation is: Number of Payback Unrecovered cost at start of year Cash flow during full recovery year = years prior to + full recovery The shorter a project's payback, the better the project is. However, payback has 3 main disadvantages: (1) Dollars received in different years are given equal weight. (2) Cash flows beyond the payback year are ignored. (3) The payback merely indicates when a project's investment is recovered. There is no necessary relationship between a given payback and investor wealth maximization. A variant of the regular payback is the discounted payback. Unlike regular payback, the discounted payback considers capital ✓costs. However, the discounted payback still disregards cash flows beyond the payback year. In addition, there is no specific payback rule to justify project acceptance. Both methods provide information about liquidity ✓and risk.
Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 12%. 0 1 2 3 4 Project A -900 600 430 200 250 Project B -900 200 365 350 700 What is Project A's payback? Round your answer to four decimal places. Do not round intermediate calculations. years What is Project A's discounted payback? Round your answer to four decimal places. Do not round intermediate calculations. years What is Project B's payback? Round your answer to four decimal places. Do not round intermediate calculations. years What is Project B's discounted payback? Round your answer to four decimal places. Do not round intermediate calculations. years
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