The Dilemma at Day Pro

The Dilemma at Day Pro

1. The payback period can be defined as the length of time it takes before the cumulated stream of forecasted cash flows equal the initial investment (Arnold 2007). By looking at Appendicle A1.0 and A1.1 we can see that the "Epoxy Resin" project has a payback period of 1.5 years while Synthetic Resin has a longer payback period of 2.5 years. On the basis of this methodology we will choose to invest in Epoxy Resin.

Though it is important to understand that payback period cannot be used as a measure of probability, as it does not take into account the cash flows after the payback period, thus making it ineffective. Another drawback to payback period is that it simply ignores the time value of money (Today's value of a payment is worth less in the future). Also we have to take into account that there is no comparison between future cash flows with primary investment and their present value when it has been discounted, secondly, it has a serious theoretical flaw the most significant being is that it ignores shareholder wealth maximization objective (Mclaney 2003)

One school of thought suggests that Payback period only demonstrates the financial feasibility of the projects technology (Attaran, 1996) and not its profitability. In this situation Tim is looking to determine which project brings maximum wealth to Day Pro, and Payback period cannot do this because it cannot measure wealth.

2. Discounted payback is very similar to the previously discussed payback method but the underlying difference is that it takes into account the time value of money. Appendicle B 1.0 and B 1.1 suggest that Epoxy Resin is the most viable project based on the discounted payback method.

This still should not be used as a deciding factor as it simply ignores all cash flows after the payback period. Gowthrope ( 2008) stated that the weakness of discounted payback is that it provides little useful information. Thus it may lead to the rejection of good wealth creating projects. Another fundamental flaw of discounted payback method is that it can easily ignore the latent energy of the product because it requires an arbitrary cut off value (Arnold 2007).

Payback period drawbacks are not significant where it is to be used to asses relatively short term, lower value projects (Chadwick 2007). In this situation it is vital for Tim to weigh the cost and the benefits of the two proposals and the payback methods cannot simply do this to an extent in which it can maximize the company's wealth.

3. Accounting rate of return is the ratio of profit before interest and taxation to the percentage of capital employed at the end of a period. Variations include using profit after interest and taxation, equity, capital employed and average capital for the

...