The Dilemma at Day Pro
The Dilemma at Day Pro
1. The payback period can be defined as the length of time it takes before the cumulated stream of forecasted cash flows equal the initial investment (Arnold 2007). By looking at Appendicle A1.0 and A1.1 we can see that the "Epoxy Resin" project has a payback period of 1.5 years while Synthetic Resin has a longer payback period of 2.5 years. On the basis of this methodology we will choose to invest in Epoxy Resin.
Though it is important to understand that payback period cannot be used as a measure of probability, as it does not take into account the cash flows after the payback period, thus making it ineffective. Another drawback to payback period is that it simply ignores the time value of money (Today 's value of a payment is worth less in the future). Also we have to take into account that there is no comparison between future cash flows with primary investment and their present value when it has been discounted, secondly, it has a serious theoretical flaw the most significant being is that it ignores shareholder wealth maximization objective (Mclaney 2003)
One school of thought suggests that Payback period only demonstrates the financial feasibility of the projects technology (Attaran, 1996) and not its profitability. In this situation Tim is looking to determine which project brings maximum wealth to Day Pro, and Payback period cannot do this because it cannot measure wealth.
2. Discounted payback is very similar to the previously discussed payback method but the underlying difference is that it takes into account the time value of money. Appendicle B 1.0 and B 1.1 suggest that Epoxy Resin is the most viable project based on the discounted payback method.
This still should not be used as a deciding factor as it simply ignores all cash flows after the payback period. Gowthrope ( 2008) stated that the weakness of discounted payback is that it provides little useful information. Thus it may lead to the
1. The payback period can be defined as the length of time it takes before the cumulated stream of forecasted cash flows equal the initial investment (Arnold 2007). By looking at Appendicle A1.0 and A1.1 we can see that the "Epoxy Resin" project has a payback period of 1.5 years while Synthetic Resin has a longer payback period of 2.5 years. On the basis of this methodology we will choose to invest in Epoxy Resin.
Though it is important to understand that payback period cannot be used as a measure of probability, as it does not take into account the cash flows after the payback period, thus making it ineffective. Another drawback to payback period is that it simply ignores the time value of money (Today 's value of a payment is worth less in the future). Also we have to take into account that there is no comparison between future cash flows with primary investment and their present value when it has been discounted, secondly, it has a serious theoretical flaw the most significant being is that it ignores shareholder wealth maximization objective (Mclaney 2003)
One school of thought suggests that Payback period only demonstrates the financial feasibility of the projects technology (Attaran, 1996) and not its profitability. In this situation Tim is looking to determine which project brings maximum wealth to Day Pro, and Payback period cannot do this because it cannot measure wealth.
2. Discounted payback is very similar to the previously discussed payback method but the underlying difference is that it takes into account the time value of money. Appendicle B 1.0 and B 1.1 suggest that Epoxy Resin is the most viable project based on the discounted payback method.
This still should not be used as a deciding factor as it simply ignores all cash flows after the payback period. Gowthrope ( 2008) stated that the weakness of discounted payback is that it provides little useful information. Thus it may lead to the
References: Attaran, M,(1996) "Gaining CIM benefits", Computers in Industry, Vol. 29 pp.225-7. The Dryden Press, 1996, Chapter 7-20, pg 8, http://www.cbe.wwu.edu/Hall/FMDS441/i5-im07b.pdf Colin, Drury, (2000) "management and cost accounting" (5th edition), Thomas Learning 2000. Catherine, Gowthrope, (2008) Management accounting 2008, Gengage Learning, EMEA. Eddie McLaney,(2003) Business Finance (Theory and practice), 6th Edition, Pearson Education Limited. Glen Arnold, (2007) Essentials of cooperate finance management, Pearson Education BNET Investopedia, URL: http://www.investopedia.com/terms/a/arr.acp, Accessed on (06/11/2008) Pike, R Stephen Keef, Melvin Roush, NPV and IRR discounted cash flow methods are widely used, but they can create conflicting signals, 1995, pg 2. David Brookfield, 1995, Management Decision, Vol 33, No 8, Pg 2. Leslie Chadwick, 2007, management accounting, 2nd edition, elements of business, pg 159