Drawbacks of payback period Does not consider all of the project’ s cash flows. (500150150150150150(300)00 012345678 This project is clearly unprofitable, but we would accept it based on a 4- year pay back criterion
Drawbacks of Payback Period • Does not consider all of the project’s cash flows. • This project is clearly unprofitable, but we would accept it based on a 4- year payback criterion! 0 1 2 3 4 5 6 7 8 (500) 150 150 150 150 150 (300) 0 0
Discounted payback Discounts the cash fows at the firm required rate of return Payback period is calculated using these discounted net cash flows Pr robles Cutoffs are still subjective Still does not examine all cash flows
Discounted Payback • Discounts the cash flows at the firm’s required rate of return. • Payback period is calculated using these discounted net cash flows. Problems: • Cutoffs are still subjective. • Still does not examine all cash flows
Discounted payback (500)250250250250250 0 3 Discounted Year Cash Flow CF(14%) 0 500 500.00 50 219.30
Discounted Payback 0 1 2 3 4 5 (500) 250 250 250 250 250 Discounted Year Cash Flow CF (14%) 0 -500 -500.00 1 250 219.30
Discounted payback (500)250250250250250 0 3 Discounted Year Cash Flow CF(14%) 0 500 500.00 50 219301year 280.70
Discounted Payback 0 1 2 3 4 5 (500) 250 250 250 250 250 Discounted Year Cash Flow CF (14%) 0 -500 -500.00 1 250 219.30 1 year 280.70
Discounted payback (500)250250250250250 0 3 Discounted Year Cash Flow CF(14%) 0 500 500.00 50 219301year 280.70 2 250 192.37
Discounted Payback 0 1 2 3 4 5 (500) 250 250 250 250 250 Discounted Year Cash Flow CF (14%) 0 -500 -500.00 1 250 219.30 1 year 280.70 2 250 192.37