Discounted Payback Period Approach

Question 1

Describe the discounted payback period approach to capital budgeting evaluation.

Answer 1

A variation of the payback period approach that takes the time value of money into account by discounting expected future cash flows.

Question 2

Identify the advantages of the discounted payback period approach to capital budgeting evaluation.

Answer 2

1. Easy to use and understand;
2. Uses time value of money approach;
3. Useful in evaluating liquidity of a project;
4. Use of a short payback period reduces uncertainty.

Question 3

Identify the disadvantages of the discounted payback period period approach to capital budgeting evaluation.

Answer 3

1. Ignores cash flows received after the payback period;
2. Does not measure total project profitability;
3. Maximum payback period may be arbitrary.

Question 4

Will the length of time required to recover an investment using the discounted payback period approach be longer or shorter than using undiscounted payback period approach (to capital budgeting)?

Answer 4

The discounted payback period will be longer than the undiscounted payback period because the present value of cash flows will be less than the undiscounted values.