The discounted payback period is used to evaluate the profitability and timing of cash inflows of a project or investment. The formula to calculate the payback period of an investment depends on whether the periodic cash inflows from the project are even or uneven. The calculation is done after considering the time value of money and discounting the future cash flows. In this case, the discounting rate is 10% and the discounted payback period is around 8 years, whereas the discounted payback period is 10 years if the discount rate is 15%. Let me explain this further. It determines the actual risk involved in a project and whether the investments made are recoverable or not. This has been a guide to discounted payback period and its meaning. The longer the payback period of a project, the higher the risk. We hope you like the work that has been done, and if you have any suggestions, your feedback is highly valuable. Payback period does not take into account the. Between mutually exclusive projects having similar return, the decision should be to invest in the project having the shortest payback period.. So, pay back here is ….
Definition of Discounted Payback Period. For companies with liquidity issues, payback period serves as a good technique to select projects that payback within a limited number of years. What is Discounted Payback Period? If the cash inflows are even (such as for investments in annuities), the formula to calculate payback period is: When cash inflows are uneven, we need to calculate the cumulative net cash flow for each period and then use the following formula: Where, In the next step, we calculate the discounted payback period using the following formula: eval(ez_write_tag([[580,400],'efinancemanagement_com-medrectangle-4','ezslot_3',117,'0','0']));Discounted Payback Period = A + B / C, A refers to the last period having negative discounted cash flow.
The next part is the division between cumulative cash flow in the year before recovery and, Year 0: – $150,000 / (1+0.10) ^0 = $150,000, Year 1: $70,000 / (1+0.10) ^1 = $63,636.36, Year 2: $60,000 / (1+0.10) ^2 = $49,586.78, Year 3: $60,000 / (1+0.10) ^3 = $45,078.89, The discounted payback period is a better option for calculating how much time a project would get back its initial investment; because, in a simple payback period, there’s no consideration for the. This target may be different for different projects because higher risk corresponds with higher return thus longer payback period being acceptable for profitable projects. It is one of the simplest investment appraisal techniques. A firm has to choose between two possible projects and the details of each project are as follows:
Discounted Payback Period = -$15,000 + $4,950.50 + $4,901.48 + $4,852.95 = -$295.04 so the payback period is over 3 years and the project is a no-go! A is the last period number with a negative cumulative cash flow; 10 years, But, if you calculate the same in simple payback, the payback period is 5 years( $30,000/$6,000), Please note that if the discount rate increases, the distortion between the simple rate of return and discounted payback period increases. Notify me of follow-up comments by email. The longer the payback period of a project, the higher the risk. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.Return to top, IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials, * Please provide your correct email id. Decision Rule.
Calculate the payback value of the project. When deciding whether to invest in a project or when comparing projects having different returns, a decision based on payback period is relatively complex. Cumulative discounted value (84,259) (67,970) (44,155) (13,614) 20,415 Fraction of next discounted c.f. It can’t be called the best formula for finding out the payback period. Payback Period = 3 + 11/19 = 3 + 0.58 ≈ 3.6 years. In this metric, future cash flows are estimated and adjusted for the time value of money. The discounted payback period calculation begins with the -$3,000 cash outlay in the starting period. B refers the value of discounted cumulative cash flow at the end of period Aeval(ez_write_tag([[250,250],'efinancemanagement_com-box-4','ezslot_5',118,'0','0'])); C refers to the discounted cash flow after the period A. eval(ez_write_tag([[250,250],'efinancemanagement_com-banner-1','ezslot_7',120,'0','0']));Calculate what is Discounted Payback Period?
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