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Discounted Payback Period
One of the major disadvantages of
simple payback period
is that it ignores the time value of
money. To counter this limitation, an alternative procedure called discounted payback period
may be followed, which accounts for time value of money by discounting the cash inflows of the
project.
Formulas and Calculation Procedure
In discounted payback period we have to calculate the present value of each cash inflow taking
the start of the first period as zero point. For this purpose the management has to set a suitable
discount rate. The discounted cash inflow for each period is to be calculated using the formula:
Discounted Cash Inflow =
Actual Cash Inflow
(1 + i)
n
Where,
i
is the discount rate;
n
is the period to which the cash inflow relates.
Usually the above formula is split into two components which are actual cash inflow and present
value factor ( i.e. 1 / ( 1 + i )^n ). Thus discounted cash flow is the product of actual cash flow
and present value factor.
The rest of the procedure is similar to the calculation of
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 Spring '09
 Stangota
 Managerial Accounting

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