ch 9 solution

# ch 9 solution - 1. To calculate the payback period, we need...

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1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the project has created: \$1,500 + 2,600 = \$4,100 in cash flows. The project still needs to create another: \$4,800 – 4,100 = \$700 in cash flows. During the third year, the cash flows from the project will be \$3,400. So, the payback period will be 2 years, plus what we still need to make divided by what we will make during the third year. The payback period is: Payback = 2 + (\$700 / \$2,900) = 2.24 years 4. When we use discounted payback, we need to find the value of all cash flows today. The value today of the project cash flows for the first four years is: Value today of Year 1 cash flow = \$6,500/1.14 = \$5,701.75 Value today of Year 2 cash flow = \$7,000/1.14 2 = \$5,386.27 Value today of Year 3 cash flow = \$7,500/1.14 3 = \$5,062.29 Value today of Year 4 cash flow = \$8,000/1.14 4 = \$4,736.64 To find the discounted payback, we use these values to find the payback period. The discounted first year cash flow is \$5,701.75, so the discounted payback for an \$8,000 initial cost is: Discounted payback = 1 + (\$8,000 – 5,701.75)/\$5,386.27 = 1.43 years For an initial cost of \$13,000, the discounted payback is: Discounted payback = 2 + (\$13,000 – 5,701.75 – 5,386.27)/\$5,062.29 = 2.38 years Notice the calculation of discounted payback. We know the payback period is between two and three years, so we subtract the discounted values of the Year 1 and Year 2 cash flows from the initial cost. This is the numerator, which is the discounted amount we still need to make to recover our initial

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## This note was uploaded on 02/23/2010 for the course FIN 81341 taught by Professor Yang during the Spring '10 term at CSU San Bernardino.

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ch 9 solution - 1. To calculate the payback period, we need...

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