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If the discounted payback method is preferable to the payback method, then why is the payback method ever used? Multiple Choice The discounted payback requires an arbitrary cutoff point while payback does not. Payback is easier to compute than discounted payback. Payback requires the Initial Investment be recovered during a project's life while the required discounted payback period may be shorter. Payback can be used with mutually exclusive projects but discounted payback cannot. Payback considers all of a project's cash flows but discounted payback does not.
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This provides a more accurate measure of a project's profitability. However, the payback method is still used for several reasons: Show more…
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Briefly explain the net present value (NPV) method and why when used in capital budgeting it is often considered superior to the payback method.
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Why do we prefer a shorter payback period if other things are equal?
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The payback of a project is the number of years it takes before the project's total cash flow is positive. Payback ignores the time value of money. It is interesting, however, to see how differing assumptions on project growth impact payback. Suppose, for example, that a project requires a $300 million investment right now. The project yields cash flows for 10 years, and the year 1 cash flow will be between $30 million and $100 million. The annual cash flow growth will be between 5% and 25% per year. (Assume that this growth is the same each year.) Use a data table to see how the project payback depends on the year 1 cash flow and the cash flow growth rate. Yearly cash flows Year Cash flow Cumulative 1 2 3 4 5 6 7 8 9 10 Year of payback= Data table for payback as a function of year 1 cash flow (along top) and annual growth rate (along side) 30 40 50 60 70 80 90 100 5% 10% 15% 20% 25% Year of payback is the year cumulative cash flow exceeds the original investment. To find this year, use the MATCH function. The MATCH function will find the year with the largest value in the lookup range that is still less than the lookup value. Therefore, the year number that MATCH returns will be one year before the actual payoff year.
Sri K.
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Horngren’s Cost Accounting
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