Thus, this value net of taxes is added on the eight year cash flow. Lastly, the cash flows are discounted using 16% cost of capital and are added up to come up with the NPV.
b. Since the decision criterion of the company is to accept projects whose payback periods are within six years, this project is viewed to have a good profit potential. Investment decision is to accept the project.
c. Different from the simple payback period, the discounted payback requires the cash flows to be discounted. Thus, it is expected that the discounted payback period is longer than the simple one. In this case, the discounted payback is 5.43 years.
3. Two of the conceptual weaknesses of the payback period are the following: inability to recognize the time-value of money by treating each dollar inflow as the same whether they are generated earlier or later in the projects life and its lack of recognition for the cash inflows after the initial investment is recouped. These flaws of the payback period make it inferior to other capital budgeting techniques. For example, because it does not discount cash flow, it is not realistic to use since we know that the value of money depreciates over time. Also, it becomes misleading when assessing projects which have lower cash flows in the early project life and large ones in its later years. The payback period almost always favor projects where the investment can