ACCA FM Syllabus D. Investment Appraisal - Adjusted Payback - Notes 5 / 5
This incorporates risk into the payback method we looked at earlier in the course
2 Methods
Add payback to NPV - Only projects with +ve NPV and payback within specified time chosen
Discount cashflows used in payback with a risk adjusted discount rate
Illustration of method 2
| Year | Cashflow |
| 0 | (1,700) |
| 1 | 500 |
| 2 | 500 |
| 3 | 600 |
| 4 | 900 |
| 5 | 500 |
Calculate discounted payback at a rate of 12%
Solution
| Year | Cashflow | 12% | Cashflow | Cumulative |
| 0 | (1,700) | 1 | (1,700) | (1,700) |
| 1 | 500 | 0.893 | 446.5 | (1,253) |
| 2 | 500 | 0.797 | 398.5 | (855) |
| 3 | 600 | 0.712 | 427.2 | (427.8) |
| 4 | 900 | 0.636 | 572.4 | 144.6 |
| 5 | 500 | 0.567 | 283.5 | 428.1 |
Discounted payback = 3 years 9 months
NPV = 428,100
Risk Adjusted Discount Rates
The discount rate should reflect:
Cost of debt
Cost of equity
The mix of the 2 above adjusted for riskiness
If a project gives additional risks then the discount factor should be altered accordingly. This is called the risk premium