FM11 42 - Answer Regular payback has two critical...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
Mini Case: 11 - 42 j. 3. What is the difference between the regular and discounted payback periods? Answer: Discounted payback is similar to payback except that discounted rather than raw cash flows are used. Setup for franchise L's discounted payback, assuming a 10% cost of capital: Expected Net Cash Flows Year Raw Discounted Cumulative 0 ($100) ($100.00) ($100.00) 1 10 9.09 (90.91) 2 60 49.59 (41.32) 3 80 60.11 18.79 Discounted Payback L = 2 + ($41.32/$60.11) = 2.69 = 2.7 years. Versus 2.4 years for the regular payback. j. 4. What is the main disadvantage of discounted payback? Is the payback method of any real usefulness in capital budgeting decisions?
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Answer: Regular payback has two critical deficiencies: (1) it ignores the time value of money , and (2) it ignores the cash flows that occur after the payback period . Discounted payback does consider the time value of money, but it still fails to consider cash flows after the payback period; hence it has a basic flaw. In spite of its deficiency, many firms today still calculate the discounted payback and give some weight to it when making capital budgeting decisions. However, payback is not generally used as the primary decision tool. Rather, it is used as a rough measure of a project's liquidity and riskiness ....
View Full Document

{[ snackBarMessage ]}

Ask a homework question - tutors are online