Question

What is the key difference between traditional profitability measures such as the cash-on-cash return, payback period, and equity dividend rate?

Do these differences make the traditional methods less valuable? Should veteran investors still use the traditional measures or only DCF methods?

Answer 1

Traditional method like cash on cash return measures the return earned in the form of monetary value i.e return earned over the value of investment. this measures the return in value.

Payback period method measures the time required to recover the Initial investment made, and it totally ignores the cash flows occurred after the payback period

Equity dividend rate is the rate of return which a investor gets as an dividend over the market price of share and this concept ignores the capital gain if any on the investment

So these are the traditional ways to calculate the profitability of the investment and a number of drawbacks are involved into these method over discounted valuation methods like NPV IRR etc

These kinds of drawback are as PBP ignores the cash flow after the recovery of initial investment, equity dividend rate ignores the capital gain and cash on cash return ignores the percentage rate of return so a veteran investor should use a mix of traditional and discounted valuation technique to investment decisions like use of payback period with discounted values will provide more effective results in comparison to simple payback period. NPV over cash to cash return will provide better results as the NPV consider the inflation effect while the latter one not.