Anne and Mary invest 4000 in their own projects. They get 400 and 600 cash flow annually, respectively. However, Mary's cash flows are to be discounted by 8%. Who has the shorted pay back period? Why is Mary's cash flow prediction more reliable?
Anne's cash flows are not discounted. 4000 divided by 400 is 10, and so, Anne's payback period is 10 years.
Mary's cash flows are discounted by 8%, so:1st year: 600 / 1.08 = 555.562nd year: 600 / 1.082 = 512.823rd year: 600 / 1.083 = 476.194rd year: 600 / 1.084 = 441.185th year: 600 / 1.085 = 408.166th year: 600 / 1.086 = 377.367th year: 600 / 1.087 = 350.888th year: 600 / 1.088 = 324.329th year: 600 / 1.089 = 30010th year: 600 / 1.0810 = 277Add them, and the NPV for Anne is approximately 4023. Therefore, Anne's payback period is earlier than Mary's. Anne's cash flow predictions are more reliable, given that NPV takes into consideration the time value of money.
