15.11 Discounted cash flow methods: discounted payback

Question 1

What is the principle behind the discounted payback method of project appraisal?

Answer 1

Determination of the time period required by a project to break even, calculated by combining techniques used in the payback period and discounted cash flow appraisal techniques.

Question 2

How is the discounted payback period calculated?

Answer 2

Discounted packback period = PV of investment / PV of annual cash flow.

Question 3

What are the advantages of the discounted payback method of project appraisal?

Answer 3

• considers the time value of money
• uses cash flow, not profit
• considers the riskiness of a project’s cash flows
• determines whether investments are recoverable

Question 4

What are the disadvantages of the discounted payback method of project appraisal?

Answer 4

• subjective and gives no concrete decision criteria
• requires an estimate of the cost of capital
• ignores cash flows beyond the discounted payback period
• calculations can becomes complex