This preview shows page 1. Sign up to view the full content.
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.
924 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.
925 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
926 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 927 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...
View Full
Document
 Fall '14

Click to edit the document details