The payback period has been used perhaps as long as capital projects themselves have been subject to fmancial analysis. Payback is a useful guide in determining the rapidity of recovering the cash outlay of an investment and as a criterion for deciding upon the acceptability of an investment project.Payback, on the other hand, has also been criticized because it does not consider the cash flows past the payback period and does not consider the time value of money. In addition, it may not correctly reflect any variability of those flows. Regardless of these shortcomings, though, the payback period continues to be widely used by management. Besides its usefulness as a measure of liquidity, perhaps there are other conceptual reasons for this continued use. The article is divided into three major sections. The first derives duration in a capital budgeting environment, notes its interpretations in this context and shows its use in the immunization of the firm's balance sheet. The second section draws intuitive and theoretical parallel between duration and the payback period indicating that payback can be used as a proxy for duration. The third section tests this relationship empirically with one hundred and seventynine different capital projects.This unpublished paper was subsequently quoted by Blocher and Stickney (1979). The end result of the prior anaiytics was reported in the paper and tested From this point on, the original derivation was a part of existing literature. This current paper completes the circle, albeit out of sequence. It presents the steps and assumptions of the original derivation, dircusses duration's potenticll application in capital budgeting, and reports the results of empirical tests. As a result, this relationship, which has become accepted in the literature, can be more fully understood. (Paper
The Supreme Court's ruling in City of Richmond v. J. A. Croson (1989) has restricted the use of government procurement assistance programs for minorities and women without the prerequisite support of a disparity study. Recently, an increasing number of disparity studies have been rejected by the courts as "junk science" and the related programs have been ruled unconstitutional. A central issue in these cases has been the approach used to estimate the availability of minority and women firms. Data from the Economic Census are commonly used as the basis for these availability estimates. However, there are significant problems and limitations with the Census data relative to the Croson guideline that the availability of women and minority firms should reflect the number of qualified, willing, and able firms. Given the number and difficulty of the required adjustments to the Census data, it is unlikely that these data will provide availability estimates that are accurate enough to allow for valid statistical tests of an inference of discriminatory exclusion. If minimizing court challenges is a goal of the public administrator who is responsible for the program, then the recommendation here is that a primary source of availability data should be considered. Furthermore, the information system needed to support the women and minority assistance programs should be designed and installed prior to initiating the program.
LEWELLEN [4] ARGUED INA RECENT article that "if risk adjusted rates are to be employed, a higher-rate treatment of cash-outflow risk is not only conceptually consistent but, indeed, mandatory from a market perspective." In support of his position, he presents a short example consisting of two projects, designated as A and B, in which the cash inflow streams are known with certainty while the outflow streams are risky. Lewellen purports to show that the capital asset pricing model (CAPM) and the "value additivity principle" suggest that the -project with the higher variance in the cash outflow should have the higher risk-adjusted discount rate (RADR).' The thrust of his position is that, ceteris paribus, an outflow stream becomes more desirable as the variance of the stream increases.We are in substantial disagreement with both Lewellen's development as well as with any implied generality of employing the standard RADR procedure in valuing outflow streams. We will first demonstrate that his conclusions do not follow from his development and will then conclude with a counter argument to his procedure.
In a recent paper, Percival and Westerfield [2] suggested that the certainty equivalent (CE) and single certainty equivalent (SCE) approaches for analyzing capital budgeting problems each incorporate implicit assumptions regarding the intertemporal pattern of uncertainty resolution. PW concluded that differences in valuing cash-flow streams using these two methods result from these implicit assumptions. They provided an example to demonstrate this apparent difference [2, p. 350, fn. 51.Unfortunately, PW made a computational error in their example. In calculating the NPV using the CE method, they discounted the expected utility of the two outcomes and then applied the inverse utility transformation. To be consistent with their development of the CE method [2, p. 3491, the inverse utility transformation should have been performed before the discounting.The application of the correct CE valuation procedure to the PW example demonstrates that there is no difference in value between the CE and SCE methods.' Therefore, PW are in error when they state that "this equality will hold only if there is no risk adjustment (only time preference adjustments) after period 0" [2, p. 3501. The equality holds in their example, which includes uncertainty that is not resolved until afterperiod 0. In fact, it can be shown that in the decision environment assumed by PW, the CE and SCE methods will always yield the same valuations for certain forms of utility functions. In particular, the equality holds for the common utility functions U = ln(F), the form used by PW *The authors share equal responsibility for the content and any errors that may appear in this paper.'The correct CE procedure is to first calculate the expected utility of the two outcomes. u = . 5 ln(50)+.5 ln(25)=3.565 The inverse utlity transformation is then applied. U-' =antilog U = 35.35 This value is then discounted to yield the NPV. N P V = -35'35 --33.67 I .05Therefore, the correct CE procedure yields the same result as was obtained by P W for the SCE method. 746
scite is a Brooklyn-based organization that helps researchers better discover and understand research articles through Smart Citations–citations that display the context of the citation and describe whether the article provides supporting or contrasting evidence. scite is used by students and researchers from around the world and is funded in part by the National Science Foundation and the National Institute on Drug Abuse of the National Institutes of Health.
customersupport@researchsolutions.com
10624 S. Eastern Ave., Ste. A-614
Henderson, NV 89052, USA
Copyright © 2024 scite LLC. All rights reserved.
Made with 💙 for researchers
Part of the Research Solutions Family.