Corporate Finance Q56

0. Alpha Corporation is considering investing €500 million with expected aftertax cash inflows of €110 million per year for six consecutive years. The required rate of return is 8 percent. The project’s payback period and discounted payback period, respectively, are closest to:

Answer
Comment
Array

Option :
Explanation :
Year 0 1 2 3 4 5 6
Cash flow (500) 110 110 110 110 110 110
umulative cash
flow
(500) (390) (280) (170) (60) 50 160
The payback is between 4 and 5 years. The payback period is 4 years plus
60/110 = 0.55 of the fifth year cash flow, or 4.55 years.
Year 0 1 2 3 4 5 6
Cash flow (500) 110 110 110 110 110 110
Discounted cash flow (500) 101.85 94.31 87.32 80.85 74.86 69.32
Cumulative DCF (500) (398.15) (303.84) (216.52) (135.67) (60.81) (8.51)
The discounted payback is between 5 and 6 years. The discounted payback period is 5 years plus 60.81/69.32 = 0.88 of the sixth year cash flow, or 5.88 years.

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