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Discounted payback period
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- Опубликовано: 7 авг 2024
- The discounted payback period method is part of the large family of capital budgeting techniques.
Here’s what you need to know about discounted payback:
1) The discounted payback method is not as simple as the “regular” payback method.
2) Discounted payback is close to, but not as “complete” as Net Present Value.
3) Very often the discounted payback period method leads to the same project selection as the payback method.
4) The discounted payback calculation outcome (in number of years) is always longer than the outcome of the “regular” payback method calculation.
⏱️TIMESTAMPS⏱️
00:00 Introduction to discounted payback
00:43 Payback method explained
02:22 Accept or reject a project based on payback period
03:03 Discounted payback method calculation
06:37 Accept or reject a project based on discounted payback
09:09 Payback period shortcomings
09:54 Discounted payback shortcomings
The payback method is often used as a first screening method for an investment. The payback method asks a very simple central question: How many years does it take to recover the initial investment? An alternative way to phrase the central question is: When do the cumulative cash flows reach zero?
The discounted payback method is very closely related to the payback method, but it poses a slightly different central question: When do the cumulative cash flows reach zero, if time value of money is applied? The “regular” payback method ignores the time value of money, while the discounted payback method incorporates it!
However, both the regular #payback method, which is nice and simple, as well as the #discountedpayback period method, which is slightly more complicated, have a crucial blind spot. The regular payback method answers the question “How many years does it take to recover the initial investment?” Nothing more, nothing less. So if project A has an investment of $1000 and 4 years of $400 benefits per year, and project D has an investment of $1000 with 5 years of $400 benefits per year, the payback method tells you that both projects are equally attractive at a payback period of 2.5 years. It simply ignores what happens after those 2.5 years!
The discounted payback period method answers the question “When do the cumulative cash flows reach zero, if time value of money is applied?” So if project A and project D have the exact same nominal cash flows as well as the exact same discounted cash flows in year 1 through 4 (as we apply the same discount rate), but project D provides one more year of benefits in year 5, then the discounted payback period method tells you bluntly that both projects are equally attractive at a discounted payback period of 3.8 years. It simply ignores what happens after those 3.8 years! This is where more sophisticated methods like Net Present Value or Internal Rate of Return have to come in to provide a very different answer.
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Enjoyed this video? Then subscribe to the channel, and check out the related videos on NPV, IRR and WACC: ruclips.net/video/N-lN5xORIwc/видео.html
😊This was exceptional and helpful. It illustrates visually what I was struggling with. Great job.
Glad it was helpful! Videos on related concepts in the NPV IRR WACC playlist: ruclips.net/video/N-lN5xORIwc/видео.html&pp=gAQBiAQB
Great job
Thank you very much!!!!
Super very useful 👌
That's wonderful to hear! Thank you for watching and commenting. More on capital budgeting techniques (terms like NPV, IRR, WACC) in this playlist: ruclips.net/video/N-lN5xORIwc/видео.html
6:29 : How do we know that it's exatcly 3.8 years ? I know that it less than 4 years, but don't know how to get that result.
You "recovered" $842 of the investment through year 1-2-3 discounted payback benefits, now you are looking for the last $158, in order to get to $1000 in total. Year 4 is expected to generate $193 in discounted payback benefits, so you only need $158 divided by $193 = 0.8 years from year 4 to get there. 3 + 0.8 = 3.8.
Ah thank you sir@@TheFinanceStoryteller
@@namelessbecky Happy to help!!! 😊
@@TheFinanceStoryteller Hello! Is it right to say that "in 3.8 years" means in "3 years 10 months" (approximately)?
@@elainejel790Yep!
if both projects have exactly the same payback period and the question mentions that without considering the time value of money we have to select one project, how do we proceed?
Mexico corporations India Ltd is considering 2 proposals of capital budgeting are mutually exclusive. The comparative figures of the same are listed below.
For Project X the initial investment is Rs. 7,25,35,680, and the expected annual cash inflows are Rs. 38,50,560, Rs. 60,50,600, Rs. 85,25,000, Rs. 98,48,500, Rs. 110,52,650, Rs. 145,80,900, Rs. 186,27,470, Rs. 90,50,600, Rs. 85,80,600, Rs. 67,75,500.
For Project Y the initial investment is Rs. 6,15,23,960, and the expected annual cash inflows are Rs. 26,50,980,
Rs. 38,15,650, Rs. 72,50,500, Rs. 95,50,400, Rs. 110,42,800, Rs. 120,80,600, Rs. 151,33,030, Rs. 95,70,800,Rs. 70,68,600, and Rs. 40,42,500. Using Pay-back period method, without giving any consideration for time value money, you are requested to help out Mexico corporations India Ltd to selec project.
Take a look for how money periods the benefits are occurring in both cases. If project A has an investment of $1000 and 4 years of $400 benefits per year, and project D has an investment of $1000 with 5 years of $400 benefits per year, the payback method tells you that both projects are equally attractive at a payback period of 2.5 years. Any entrepreneur with skin in the game would intuitively and correctly choose project D over project A, without having heard of any of the more fancy terms. See also: ruclips.net/video/FJjGi7gsK3A/видео.html
Isn't the payback period supposed to be 2.6 yrs ? 200/400×12
2 years and 6 months is the same as 2.5 years.