Discounted Payback

The time period required to get back the invested amount is called discounted payback period. It can also be termed as the time required for reaching the initial cash flow from the discounted cash flow.

Some of the advantages of discounted payback period method are,

• It considers the time value of the money. Time plays a major factor in investment decision. The time value of money is found by finding the weighed average cost of capital.
• The time period calculation is simpler than most of the other method.
• The handling of funds is effective in this method.
• It is considered to be one of the simplest forms of calculation.
• It is easier to compare two investments using this method.

Some of the disadvantages in discounted pay back period method are,

• It does not suit the financial table which is very long in size.
• In most of the real life situation borrower tends to pay more than what is got through this calculation.
• This method does not take into consideration the factor called inflation. In real life business scenario inflation plays a major role. It is a huge factor which cannot be left without consideration in taking business decision.
• The interest rate are not completely covered, interest rate if involved has a huge restriction. It does not have a complete involvement of the interest rate.
• The cash flow beyond the payback period is totally ignored, but these cash flows are the one which decide the profit to the organization.
• The cost of capital must be calculated in order to go through this process. In real life business scenario calculation the cost of capital is a tedious process and involves a huge man power if the business size is huge.
• It does not consider risk.
• It does not consider opportunity cost.
• Complexity increases when there is a change in the sign of the cash flow from positive to negative and vice versa.

The alternative methods the modern economist uses for this method are net present value method and internal rate of return method. These two methods has reduced drastically the flaws that this discounted payback method has.

Question  

• What are the advantages of discounted payback method?
• What are the disadvantages of discounted payback method?