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This week's discussion is another area that I lack familiarity and direct life application. I have done simple evaluations of investment worth, but nothing scientific. The closest application of any of the rules would be the payback rule. For example, purchasing a good car can be a payback evaluation. The decision may be determined in adding a delivery service to a restaurant. You may calculate the average price of delivery to account for fuel, mileage, maintenance, and cost. Then you would evaluate the increased revenue to see how long you would have to run the service to pay for the vehicle investment, which will provide an evaluation of benefit. The drawbacks are that the payback rule ignores the time value of money, requires an arbitrary cutoff point, and ignores cash flows after the payback point. This leads to a biased result that doesn't fully represent the benefit of the investment. For example, the vehicle could run long after the payback point, but the benefits will be left out of the calculations.
Ross, S., Westerfield, R., & Jordan, B. (2013). Fundamentals of Corporate Finance (10th). New York, NY: McGraw-Hill/Irwin.
You are absolutely correct in your understanding of the simple payback rule. As you indicate it calculates your investment and then simply determines the time it takes to recoup that investment. There are a lot of drawbacks associated with the ...
This solution discusses bond and stock valuation.