Does the payback rule account for the time value of

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Does the payback rule account for the time value of money?Does the payback rule account for the risk of the cash flows?Does the payback rule provide an indication about the increase in value?Should we consider the payback rule for our primary decision rule?AdvantagesDisadvantagesEasy to understand and compute (you just subtract!)Simple to use Adjusts for uncertainty of later cash flowsBiased toward liquidityQuickly frees up cash for other projects Ignores the time value of moneyRisk is not consideredRequires an arbitrary cutoff pointIgnores cash flows beyond the cutoff dateBiased against long-term projects, such as research and development, and new projectsIV. Discounted Payback RuleInvestment is acceptable if its calculated discounted payback is less than some prespecified number of years.Discounted payback period - length of time until the present value of the accumulated cash flows equal or exceed the original investmentto compute:- find the present value of all cash flows- sum the present value of the cash inflows, beginning with the first period- stop at the time period in which the accumulation of the present value of the cash inflows equals the initial cash outflow6
Example 3: What is the discounted payback period for the project? If we require a discounted payback of 2 years, should we accept the project?Decision Criteria for Discounted PaybackDoes the discounted payback rule account for the time value of money?Does the discounted payback rule account for the risk of the cash flows?Does the discounted payback rule provide an indication about the increase in value?Should we consider the discounted payback rule for our primary decision rule?AdvantagesDisadvantagesIncludes TVMSimple to use. Easy to understandProvides information on how long funds will be tied up in a projectThe payback rule is biased towards liquidityquickly frees up cash for other investmentsDoes not reject positive NPV projects when allfuture cash flows are positiveMay reject positive NPV projectsRequires an arbitrary cutoff pointIgnores cash flows beyond the cutoff dateBiased against long-term projects, such as research and development, and new projects7

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