Discounted Payback Periods

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Definition of 'Discounted Payback Periods'

The discounted payback period (DPP) is a capital budgeting technique used to evaluate the profitability of an investment. It is calculated by taking the initial investment and dividing it by the net present value (NPV) of the project's cash flows. The resulting number is the number of years it will take for the project to pay back its initial investment.

The DPP is a simple and intuitive measure of a project's profitability. However, it has several limitations. First, it does not take into account the time value of money. Second, it does not consider the cash flows after the payback period. Third, it does not consider the risk of the project.

Despite its limitations, the DPP can be a useful tool for evaluating the profitability of a project. It is especially useful for projects with short payback periods or for projects where the cash flows are uneven.

Here is a more detailed explanation of how to calculate the discounted payback period:

1. First, you need to estimate the project's cash flows. This includes the initial investment, as well as the cash flows that the project will generate over its lifetime.
2. Next, you need to discount the cash flows to their present value. This is done by using a discount rate, which is the rate of return that you would expect to earn on an investment of similar risk.
3. Once you have the present value of the cash flows, you can divide the initial investment by the NPV to get the discounted payback period.

The discounted payback period is a useful tool for evaluating the profitability of a project, but it has several limitations. It does not take into account the time value of money, it does not consider the cash flows after the payback period, and it does not consider the risk of the project.

Despite its limitations, the discounted payback period can be a useful tool for evaluating the profitability of a project. It is especially useful for projects with short payback periods or for projects where the cash flows are uneven.

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