Question
Fuzzy Button Clothing Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover
Fuzzy Button Clothing 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 Sigma's expected future cash flows. To answer this question, Fuzzy Button's CFO has asked you to compute the projects payback period using the expected net cash flows and assuming that the cash flows are received evenly throughout each year.
Complete the following table and compute the projects conventional payback period. For full credit, Complete the entire table.
| Year 0 | Year 1 | Year 2 | Year 3 |
Expected Cash Flow | -4,000,000 | $1,600,000 | $3,400,000 | $1,400,000 |
Cumulative Cash Flow | | | | |
Conventional Payback Period | _____ years | | | |
The conventional payback period ignores the time value of money, and this concerns Fuzzy Buttons CFO. He has now asked you to compute Sigma's discounted payback period, assuming the company has a 8% 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 0 | Year 1 | Year 2 | Year 3 |
Cash Flow | -4,000,000 | $1,600,000 | $3,400,000 | $1,400,000 |
Discounted Cash Flow | | | | |
Cumulative Discounted Cash Flow | | | | |
Discounted payback period | ____years | | | |
Which version of a project's payback period should the CFO use when evaluating Project Sigma, given its theoretical superiority?
A. the regular payback period
B. the discounted payback period
How much should value does the discounted payback period method fail to recognize due to this theoretical deficiency?
A. $4,026,317
B.$1,111,365
C.$2,592,846
D. $1,507,798
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