CFA Level 1: Projected Cash Flow for Year 4

Projected Cash Flow for Year 4

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Question

A firm is considering a project whose estimated cash flows have indicated a payback period of 3.68 years. It requires an initial outlay of $1,000 and has end-of- year cash flows of $350, $270 and $225 in the first 3 years. The firm's marginal discount rate is 9%. The project's projected cash flow for year 4 equals ________.

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Explanations

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A. B. C. D.

Explanation

The payback period is defined as the expected number of years that would be required to recover the original investment. In particular, Payback period = Years before full recovery + (unrecovered cost at the start of payback year)/(net cash flow in the payback year) In this case, the recovery occurs in the 3rd year. At the beginning of the 3rd year, the unrecovered cost equals 1,000 - 350 - 270 - 225 = 155. If total cash flow in the 4th year equals C, then payback period = 3 + 155/C

= 3.68 years. Solving for C gives C = 228. Note that the discount rate does not figure in the calculation of payback period.

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