Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

IV. Capital Budgeting 9. Net Present Value and

Other Investment Criteria

(^314) © The McGraw−Hill
Companies, 2002
because the cutoff is too short. Also, just because one project has a shorter discounted
payback than another does not mean it has a larger NPV.
All things considered, the discounted payback is a compromise between a regular
payback and NPV that lacks the simplicity of the first and the conceptual rigor of the
second. Nonetheless, if we need to assess the time it will take to recover the investment
required by a project, then the discounted payback is better than the ordinary payback
because it considers time value. In other words, the discounted payback recognizes that
we could have invested the money elsewhere and earned a return on it. The ordinary
payback does not take this into account. The advantages and disadvantages of the dis-
counted payback rule are summarized in the following table.
284 PART FOUR Capital Budgeting

FIGURE 9.3

700

600

500

400

300

200

100

Future

value ($)

Year

0 1 2 3 4 5

$481

$541

$642

FV of initial investment

FV of projected cash flow

Future Value of Project Cash Flows

Future Value at 12.5%

$100 Annuity $300 Lump Sum

Year (projected cash flow) (projected investment)

0 $0 $300

1 100 338

2 213 380

3 339 427

4 481 481

5 642 541