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Distinguish between the payback period and the discounted payback period?

Distinguish between the payback period and the discounted payback period?

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Expert Solution

Answer:- Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.

When cash inflows are uneven, then calculate cumulative net cash flow for each period and

Then use the following formula for payback period:

Payback period =A+B/C

Where:-

A is the last period with a negative cumulative cash flow;
B is the absolute value of cumulative cash flow at the end of the period A;
C is the total cash flow during the period after A

In discounted payback period we have to calculate the present value of each cash inflow taking the start of the first period as zero point. For this purpose the management has to set a suitable discount rate. One of the major disadvantages of simple payback period is that it ignores the time value of money.The discounted cash inflow for each period is to be calculated using the formula:

Discounted Cash Inflow = Actual Cash Inflow/(1+i)n

Where,
   i is the discount rate;
   n is the period to which the cash inflow relates.

ekkarill92 answered 1 year ago
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