Payback/NPV

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moregreat

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May its little dumb to ask but, if the Payback as compared to a benchmark is good (i.e. for example Discounted Payback is 3.5 and benchmark is 5) however the same project has a negative NPV over its life. Will you select that project for investment purposes???

TIA
 
I guess company selects project which will give their share holder maximum profit so NPV has to be positive.
 
No (to the original question). You will get your invested money back at 3.5 years only to lose it in the remainer of the project.

Conceptually, to have a "good" DPP but a "bad" NPV the final years of the project have to poor cash flows relative to your hurdle rate.

If you are investing for profitability use NPV. DPP is only a measure of liquidity.



Edited 1 time(s). Last edit at Monday, May 14, 2007 at 02:24PM by mwvt9.
 
mwvt9 and cfaboston - so it means that to take an overall project investment decision, regardless of liquidity, I mean the payback could be as long as projects life, still the project will be selected based on (+ve) NPV even though its not as liquid.
 
If it is a small company, and close-held, pay back period method is widely used. However, the manager still have mixed feeling on whether rejecting the project, if the NPV is negative and pay back period is good. Because the owner of the company still worry about the opportunity cost.

For a large public company, the project with nagetive NPV is always rejected, even though the pay back period is good. Because it will destroy shareholder vaule. The public company's share price will drop immediately when the news of new negative NPV project being released.



Edited 3 time(s). Last edit at Monday, May 14, 2007 at 05:45PM by oversun.
 
I do not understand how NPV can be negative with a valid Discounted Payback Period.
Does that mean the project requires additional cash infusion in the later stages?
 
DPP just tells you when you have got back the money you invested..taking into account the TVM. DPP then IGNORES any cash flows past this point.

It is possible to have negative cash flows late in a project (after you have acheived payback of your investment and satisfied DPP) which would give you a negative NPV for the project.

You could also have positive cash flows at the end of the project that weren't high enough to get above your hurdle rate (discount rate) and the NPV could end up negative.

Hope this helps.

Fellow Pittsburgher,

mwvt9
 
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