discounted payback period

(noun)

The discounted payback period is the amount of time that it takes to cover the cost of a project, by adding positive discounted cash flow coming from the profits of the project.

Related Terms

Examples of discounted payback period in the following topics:

  • Discounted Payback

    • Discounted payback period is the amount of time to cover the cost, by adding positive discounted cash flow coming from the profits of the project.
    • Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • Compared to payback period, the discounted payback period takes the time value of money into consideration.
    • An implicit assumption in the use of payback period is that returns to the investment continue after the payback period.
    • Payback period does not specify any required comparison to other investments or even to not making an investment.

  • Calculating the Payback Period

    • To calculate a more exact payback period: Payback Period = Amount to be initially invested / Estimated Annual Net Cash Inflow.
    • Payback period is usually expressed in years.
    • Some businesses modified this method by adding the time value of money to get the discounted payback period.
    • They discount the cash inflows of the project by a chosen discount rate (cost of capital), and then follow usual steps of calculating the payback period.
    • The modified payback period algorithm may be applied then.

  • Defining Capital Budgeting

    • Payback period: For example, a $1000 investment which returned $500 per year would have a two year payback period.
    • Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • Payback period intuitively measures how long something takes to "pay for itself. " All else being equal, shorter payback periods are preferable to longer payback periods.
    • The payback period is considered a method of analysis with serious limitations and qualifications for its use, because it does not account for the time value of money, risk, financing, or other important considerations, such as the opportunity cost.
    • Simplified and hybrid methods are used as well, such as payback period and discounted payback period.

  • Disadvantages of the Payback Method

    • Payback period analysis ignores the time value of money and the value of cash flows in future periods.
    • An implicit assumption in the use of payback period is that returns to the investment continue after the payback period.
    • Payback period does not specify any required comparison to other investments or even to not making an investment.
    • Payback also ignores the cash flows beyond the payback period, thereby ignoring the profitability of the project.
    • The modified payback period algorithm may be applied then.

  • Defining the Payback Method

    • A $1000 investment which returned $500 per year would have a two year payback period.
    • In capital budgeting, the payback period refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • As a stand-alone tool to compare an investment, the payback method has no explicit criteria for decision-making except, perhaps, that the payback period should be less than infinity.
    • An implicit assumption in the use of the payback method is that returns to the investment continue after the payback period.
    • The payback period is usually expressed in years.

  • Advantages of the Payback Method

    • All else being equal, shorter payback periods are preferable to longer payback periods.
    • The payback period is an effective measure of investment risk.
    • The project with a shortest payback period has less risk than with the project with longer payback period.
    • Payback period method is suitable for projects of small investments.
    • The business is more likely to use payback period to choose a project.

  • Ranking Investment Proposals

    • Several methods are commonly used to rank investment proposals, including NPV, IRR, PI, payback period, and ARR.
    • An NPV calculated using variable discount rates (if they are known for the duration of the investment) better reflects the situation than one calculated from a constant discount rate for the entire investment duration.
    • Payback period intuitively measures how long something takes to "pay for itself. " All else being equal, shorter payback periods are preferable to longer payback periods.
    • Payback period is widely used because of its ease of use despite the recognized limitations: The time value of money is not taken into account.
    • Each cash inflow/outflow is discounted back to its present value (PV).

  • Discounted Cash Flow Approach

    • -- To find the discounted present value of an asset, it is necessary to sum the discounted present value of each future cash flow (FV) at any time period (t) in years from the present time, using the appropriate interest rate (i).
    • -- FCFN+1 = future cash flow one year after the projection period. k = discount rate. g = assumed constant growth rate.
    • Where TV = terminal value, k = discount rate, and n = the number of periods back to the present.
    • FCFN+1 = future cash flow one year after the projection period. k = discount rate. g = assumed constant growth rate.
    • To find the discounted present value of an asset, it is necessary to sum the discounted present value of each future cash flow (FV) at any time period (t) in years from the present time, using the appropriate interest rate (i).

  • Present Value of Payments

    • The value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate.
    • Therefore, the value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate.
    • In practice, this discount rate is often determined by reference to similar instruments, provided that such instruments exist.
    • The formula for calculating a bond's price uses the basic present value (PV) formula for a given discount rate .
    • i is the number of periods and n is the per period interest rate.

  • The Discount Rate

    • Discounting is the procedure of finding what a future sum of money is worth today.
    • Another common name for finding present value (PV) is discounting.
    • Discounting is the procedure of finding what a future sum of money is worth today.
    • As you know from the previous sections, to find the PV of a payment you need to know the future value (FV), the number of time periods in question, and the interest rate.
    • The interest rate, in this context, is more commonly called the discount rate.