Comparing payback period and discounted payback period. Nielsen Inc.

is switching from
the payback period to the discounted payback period for small-dollar projects. The cutoff
period will remain at three years. Given the following four projects' cash flows and using
a 10% discount rate, determine which projects it would have accepted under the payback
period and which it will now reject under the discounted payback period.

ANSWER
Calculate the Discounted Payback Periods of each project at 10% discount rate:
Project One
Present Value of cash flow year one = $4,000 / 1.10 = $3,636.36
Present Value of cash flow year two = $4,000 / 1.102 = $3,305.78 Present Value of cash
flow year three = $4,000 / 1.103 = $3,005.26
Discounted Payback Period = -$10,000 + $3,636.36 + $3,305.78 + $3,005.26 = -$52.60 so
the discount payback period is over 3 years and the project is a no-go!
Project Two
Present Value of cash flow year one = $7,000 / 1.10 = $6,363.64
Present Value of cash flow year two = $5,500 / 1.102 = $4,545.46
Present Value of cash flow year three = $4,000 / 1.103 = $3,005.26
Discounted Payback Period = -$15,000 + $6363.64 + $4.545.46 + $3,005.26 = -1,085.64 so
the discount payback period is over 3 years and the project is a no-go!
Project Three
Present Value of cash flow year one = $3,000 / 1.10 = $2,272.73
Present Value of cash flow year two = $3,500 / 1.102 = $2,892.56
Present Value of cash flow year three = $4,000 / 1.103 = $3,005.26
Discounted Payback Period = -$8,000 + $2,272.73+ $2,892.56 + $3,005.26 =
$625.55 so the discount payback period is under 3 years and the project is a go!
Project Four
Present Value of cash flow year one = $10,000 / 1.10 = $9,090.91
Present Value of cash flow year two = $11,000 / 1.102 = $9,090.91
Present Value of cash flow year three = $0 / 1.103 = $0
Discounted Payback Period = -$18,000 + $9,090.91 + $9,090.91 + $0 = $181.82 so the
discount payback period is under 3 years and the project is a go!
Projects one and two will now be rejected using discounted payback period with a discount
rate of 10%.