In most discussions of capital budgeting, the net present value (NPV) method is hailed as the best method for ranking mutually exclusive projects. Managers rarely rely upon a single method of evaluating projects. The NPV method is generally accompanied by several other methods. One method commonly included in the analysis is the payback method, which measures the length of time it takes for the future cash flows of the project to return the initial capital that is invested in the project. Longer payback periods are viewed as an indication of a less favorable project. Most discussions of payback methods have focused upon its shortcomings and the dangers of relying upon it. It is often illustrated that a project with a short payback can have a negative NPV, meaning that the project would pass the payback test, but even so, be unacceptable. Our paper begins with a brief literature review, then compares and illustrates the NPV and payback methods. Our model is then presented with its application to an example of two mutually exclusive projects and we end the paper with a conclusion with some practical advice to the managers.
suggested citation:
Alka Bramhandkar and Jeffrey Lippitt. "Payback Adjusted Net Present Value." Proceedings of the New York State Economics Association. vol. 1, October 2008, p. 310
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