Marketing Tips

Today in my marketing class, I learned about net present value and the payback period. Now you may be asking me why I am blogging about this since my previous posts have been about forex trading. However, I feel that this is a very important concept that more people should be aware of.

First off, let me discuss what the payback period is. The meaning of the payback period is simply the number of years needed to recover the initial cash outlay of a capital budgeting project. The decision rule for the pay back period is that the project feasible or desirable if the payback period is less than or equal to the firm’s maximum desired payback period. In general, shorter payback period is preferred while comparing two projects.

Benefits of Payback Period
-Uses cash flows rather than accounting profits
-Easy to compute and understand
-Useful for firms that have capital constraints, because provides liquidity needs for the firm
-Emphasizes earlier returns which have less uncertainty than later cash flows

Drawbacks of Payback Period
-Ignores the time value of money
-Ignores CFs occurring after the payback period
-Firm cutoffs are subjective
-Does not consider any required rate of return
-Biased against long-term projects, such as research and development, and new projects

Net Present Value on the other hand is equal to the present value of all future free cash flows less the investment’s initial outlay. It measures the net value of a project in today’s dollars. Below are some benefits and drawbacks to this method.

Benefits
-Considers cash flows, not profits
-Considers all cash flows
-Recognizes time value of money
-By accepting only positive NPV projects, increases value of the firm

Drawbacks
-Requires detailed long-term forecast of cash flows

NPV is considered to be the most theoretically correct criterion for evaluating capital-budgeting projects.

Hopefully this blog has brought interest to some of you who are interested in marketing. By following these methods and theories, it will help you succeed in the future if you decide to invest in a business venture. Feel free to leave a comment if you have any questions!