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Discounted Cash Flow and Payback - Research Paper Example

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The paper "Discounted Cash Flow and Payback" presents that the payback period for Marine Limited’s capital expenditure is 2 years and 2 months. [Working: 5740 ÷ 32895 × 12 months]. The payback period for Dive Limited’s capital expenditure is 3 years and 8 months. [Working: 18630 ÷ 27240 × 12 months]…

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Subject: Business
Type: Research Paper
Level: Masters
Pages: 1 (250 words)
Downloads: 2
Author: fay56

Extract of sample "Discounted Cash Flow and Payback"

The ARR also favors Project 1, therefore the expected profitability of the project is higher than the profitability of Project 2.

TASK 2: UNDISCOUNTED CASH FLOW – PAYBACK PERIOD

YEARS

PROJECT 1

CASH INFLOW/ OUTFLOW

BALANCE

PROJECT 2

CASH INFLOW/ OUTFLOW

BALANCE

(90,000)

(90000)

20000

(70000)

10000

(80000)

80000

10000

40000

(40000)

45000

55000

40000

20000

The payback period for Project 1 is 1 year and 11 months. [Working: 70000 ÷ 80000 × 12 months].

The payback period for Project 2 is 2 years.

If the time value of money is ignored, Project 1 is again more profitable as it involves less risk as compared to the undertaken of Project 2 which has a higher payback period.

TASK 3: ADVANTAGES AND DISADVANTAGES:

DISCOUNTED CASH FLOW:

The method takes into account the time value of money.
It produces more meaningful results than the payback period.
It is more complicated than ARR and Payback and requires a number of calculations if solved manually.

PAYBACK:

It is simple to calculate.
The calculation of net cash flows is more objective than the calculation of profitability.
It indicates the project with the least risk.
It ignores the life expectancy of a project.
Two projects may have a similar payback period even though the pattern of cash inflows may be different.
It ignores the time value of money.

ACCOUNTING RATE OF RETURN

It is easy to calculate.
It can be used to compare the expected profitability of a project with the present profitability of the business.
It is based on average annual profit which may not be similar for each year.
The timing of cash flows is ignored.
It also ignores the time value of money.
There is no commonly accepted method of calculating capital employed.
It takes no account of the duration of the project.

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