Dilemma of a Day-Pro

http://www.scribd.com/doc/179814698/The-Dilemma-at-Day-Pro-case-docx

1. Project 1

Year Cash Flow Net Cash Flow

0 -1,000,000 -1,000,000

1 350,000 -650,000

2 400,000 -200,000

3 500,000 300,000

4 650,000 950,000

5 700,000 1,650,000

Payback period:

2+(200,000)/(500,000) = 2.4 years

Project 2

Year Cash Flow Net Cash Flow

0 -800,000 -800,000

1 600,000 -200,000

2 400,000 200,000

3 300,000 500,000

4 200,000 700,000

5 200,000 900,000

Payback period:

1+(200,000)/(400,000) = 1.5

The better investment is the one with the shorter payback period. This method ignores any benefits that occur after the payback period and does not measure profitability. The second problem is that it ignores the time value of money. Because of these reasons other methods of capital budgeting, like internal rate of return or discount cash flow and Net present value are generally preferred.

2. Discount payback period

This method takes in considertation the time value of money.

Discount Cash flow = (Actual Cash Flow/ (1+i)N

I = 10%

Project 1

Year Cash Flow Discount Cash Flow

0 -1,000,000 -1,000,000

1 350,000 318,181.8

2 400,000 330,578.5

3 500,000 375,657.4

4 650,000 951,665

5 700,000 1,127,357

Assignment 1