Premier Paper Co
Payback period is the time it takes to recoup your initial investment on a project based upon the future cash flows the project is expected to generate. In question one, the synthetic resin has a payback period of 2.50 years where as the epoxy resin has a payback period of 1.50 years, meaning the company will recoup its initial investment one year sooner with the epoxy resin than with the synthetic resin. If the company were determining which project to choose based solely on the payback period, it would choose the epoxy resin.
However, the payback period is flawed as a sole decision-making criterion. A major flaw of the payback period is that it does not take into consideration cash flows after the payback period, thus, potentially eliminating projects that are more profitable in the long-run. Another flaw with the payback period is that it does not take into account the time value of money nor does it reflect the value the project will have to the company, it simply gives a rough estimate of when the project is expected to pay for itself. Also, in a mutually exclusive decision like the one given, the payback period does not account for differing initial investment amounts. This means there will always be some degree of bias toward investments that require less initial funding.
The discounted payback period (DPP) is similar to the aforementioned payback period except with the added benefit of accounting the time value of money. This is a more accurate calculation as to when the company will receive back the cost of initial investment. The DPP’s for the synthetic resin and epoxy resin are 2.94 years and 1.77 years respectively. Again, the epoxy resin has a payback period that is sooner, but like the payback period, the DPP does not consider any cash flows after the initial investment is recouped. DPP still supports the decision of epoxy but has done little to combat the flaws found in the payback period.
The average accounting return (AAR) takes the
However, the payback period is flawed as a sole decision-making criterion. A major flaw of the payback period is that it does not take into consideration cash flows after the payback period, thus, potentially eliminating projects that are more profitable in the long-run. Another flaw with the payback period is that it does not take into account the time value of money nor does it reflect the value the project will have to the company, it simply gives a rough estimate of when the project is expected to pay for itself. Also, in a mutually exclusive decision like the one given, the payback period does not account for differing initial investment amounts. This means there will always be some degree of bias toward investments that require less initial funding.
The discounted payback period (DPP) is similar to the aforementioned payback period except with the added benefit of accounting the time value of money. This is a more accurate calculation as to when the company will receive back the cost of initial investment. The DPP’s for the synthetic resin and epoxy resin are 2.94 years and 1.77 years respectively. Again, the epoxy resin has a payback period that is sooner, but like the payback period, the DPP does not consider any cash flows after the initial investment is recouped. DPP still supports the decision of epoxy but has done little to combat the flaws found in the payback period.
The average accounting return (AAR) takes the