For example the pv of 56357 is based on fv63120 n1

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Unformatted text preview: s back on a discounted basis in 2 years. Costs in year 0 are -165,000 and future cash flows are 63,120 in year 1, 70,800 in year 2 and 91,080 in year 3. Use I=12%. Time 0 1 2 3 Amount -165,000 63,120 70,800 91,080 PV at time 0 -165,000 56,357 56,441 64,829 • • Answer: Step 1: Compute the PV at time 0 for each cash flow one by one. For example, the PV of 56,357 is based on FV=63120, N=1, I=12 • Step 2: Determine the payback period using the discounted cash flows. • Year 1: 56,357, not paid back. • Year 2: 56,357 + 56,441 = 112,798, not paid back. • Year 3: 112,798 + 64,829 = 177,627, so paid back in year 3 • We reject the project. 9-24 Precise discounted cash flow • The precise payback Time Amount PV at time 0 period can be computed 0 -165,000 -165,000 based on the cumulated 1 63,120 56,357 discounted cash flows in 2 70,800 56,441 year 2, which is 56,357 + 3 91,080 64,829 56,441 = 112,798 • The remainder is 165,000 • Casio calculator: Enter - 112,798 = 52,202. the undiscounted cash • This represents the flow into the calculator (ie. following share of the the 63120, etc.) year 52,202 / 64,829 = • Enter I=12% and choose 0.81 F3 for PBP. • So the precise payback period is 2.81 years. 9-25 Comparing discounted and undiscounted payback period • Discount rate is 12.5%, project cost is $300. • Regular payback period is 3 years and the discounted payback period is 4 years • Intuitive/loose understanding of discounted payback: you get your initial investment back along with the interest that could have been earned elsewhere in 4 years 9-26 Advantages and Disadvantages of Discounted Payback • Advantages • Includes time value of money • Easy to understand • Does not accept negative estimated NPV investments • Biased towards liquidity • Disadvantages • May reject positive NPV investments • Requires an arbitrary cutoff point • Ignores cash flows beyond the cutoff date • Biased against longterm projects, such as R&D, and new projects 9-27 Decision Criteria Test – Discounted Payback • Does the discounted payback rule account for the time value of money? Yes • Does the discounted payback rule account for the risk of the cash flows? Yes, through the dis...
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