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**Unformatted text preview: **ule provide an indication
Does
about the increase in value?
about
Should we consider the payback rule for our
Should
primary decision rule?
primary 13
13 Advantages and Disadvantages
Advantages
of Payback
of Advantages Easy to understand
Adjusts for uncertainty
Adjusts
of later cash flows
of
Biased toward liquidity Disadvantages Ignores the time value
Ignores
of money
of
Requires an arbitrary
Requires
cutoff point
cutoff
Ignores cash flows
Ignores
beyond the cutoff date
beyond
Biased against longterm projects, such as
term
research and
development, and new
projects
projects
14
14 Discounted Payback Period Compute the present value of each cash flow
Compute
and then determine how long it takes to pay
back on a discounted basis
back
Compare to a specified required period
Decision Rule - Accept the project if it pays
Decision
back on a discounted basis within the
specified time
specified 15
15 Computing Discounted Payback for
Computing
the Project
the Assume we will accept the project if it pays back on a
Assume
discounted basis in 2 years.
discounted
Compute the PV for each cash flow and determine the
Compute
payback period using discounted cash flows
payback Year 1: 165,000 – 63,120/1.121 = 108,643
Year 2: 108,643 – 70,800/1.122 = 52,202
Year 3: 52,202 – 91,080/1.123 = -12,627 project pays back in
year 3
year Do we accept or reject the project? 16
16 Decision Criteria Test – Discounted
Decision
Payback
Payback Does the discounted payback rule account for the time
Does
value of money?
value
Does the discounted payback rule account for the risk
Does
of the cash flows?
of
Does the discounted payback rule provide an indication
Does
about the increase in value?
about
Should we consider the discounted payback rule for
Should
our primary decision rule?
our 17
17 Advantages and Disadvantages of
Advantages
Discounted Payback
Discounted Advantages Includes time value of
Includes
money
money
Easy to understand
Does not accept
Does
negative estimated
NPV investments
when all future cash
flows are positive
flows
Biased towards
Biased
liquidity
liquidity Disadvantages May reject positive
May
NPV investments
NPV
Requires an arbitrary
Requires
cutoff point
cutoff
Ignores cash flows
Ignores
beyond the cutoff point
beyond
Biased against longterm projects, such as
term
R&D and new
products
products
18
18 Average Accounting Return There are many different definitions for average
There
accounting return
accounting
The one used in the book is: Average net incom...

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