Using these criteria financial analysts seek to

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Unformatted text preview: l 'analysts seek to identify those projects that will lead to the maximization of the firm's stock price. Payback Period The payback period is defined as the expected number of years required to recover the investment, and it was the first formal method used to evaluate capital budgeting projects. First, we identify the year in which the cumulative cash inflows exceed the initial cash outflows. That is the payback year. Then we take the previous year and add to it unrecovered balance at the end of that year divided by the following year's cash flow. Generally speaking, the shorter the payback period, the better the investment. Project S Time period: Cash flow: Cumulative cash flow: 0 (1,000) (1,000) 0.00 0.00 2 .33 Payback: Alternative calculation: 1 500 (500) 0 .00 0 .00 2 4 00 (100) 0 .00 0 .00 3 300 200 1.00 2 .33 4 100 300 Click fx > Log ical > AND > OK to g et dialog box. 0 .00 Use Log ical "AND" to determine Then specify you want TRUE if cumulative CF > 0 but the previous CF < 0. 0 .00 the first positive cumulative CF. There will be one TRUE. Use Log ical IF to find the Payback. Click fx > Log ical > IF > OK. Specify that if true, the payback is the previous year plus a fraction, if false, then 0. Use Statistical Max function to Click fx > Statistical > MAX > OK > and specify rang e to find Payback. display payback. 1 100 (900) 2 300 (600) 3 4 00 (200) 4 6 00 4 00 2.33 Project L Time period: Cash flow: Cumulative cash flow: 0 (1,000) (1,000) P ayback: 3.33 Uses IF statement. Discounted Payback Period Discounted payback period uses the project's cost of capital to discount the expected cash flows. The calculation of discounted payback period is identical to the calculation of regular payback period, except you must base the calculation on a new row of discounted cash flows. Note that both projects have a cost of capital of 10%. WACC = 10% Project S Time period: Cash flow: Disc. cash flow: Disc. cum. cash flow: 0 (1,000) (1,000) (1,000) Discounted Payback: 1 500 4 55 (54 5) 2.95 2 4 0...
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