A project costs $100,000 in year 0. Cash inflows are Y1 = $30,000, Y2 = $50,000, Y3 = $70,000, where year 0 is the present, and Y1, Y2, and Y3 are the inflows in one, two, and three years, respectively. Assume a discount rate of 12%. Figure 10–2 provides a format for computing discounted payback.

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Projects with the shortest discounted payback ranked highest. This method has an advantage over the simple payback method because it considers the time value of money. Since it provides information on how quickly investments are recovered, it addresses liquidity and cash flow issues. However, it still suffers from one of the payback method’s shortcomings. It doesn’t consider the value of cash generated beyond the payback date.
Let’s look at projects A and B in more detail (see Figure 10–3). Both require a $100,000 investment, and A pays $50,000 for three years, whereas B pays $40,000 for eight years. For purposes of this example, assume a discount rate of 10%.
Project B generates far more cash over its lifetime than project A, even though project A ranks higher than project B in both the payback and discounted payback method. Fortunately, there is a method that considers the present value of the cash generated over the life of a project. It is the net present value method.

Question 10.2: A project costs $100,000 in year 0. Cash inflows are Y1 = $3...

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