Here are the four parts of the basic present value equation:

1. Future Value (FV): The amount of money you expect to receive at a future date. It’s the value of a cash flow at a specific point in the future.
2. Present Value (PV): The current value of that future cash flow, discounted back to today’s dollars using a specified discount rate. It represents the worth of the future cash flow in today’s terms.
3. Discount Rate (r): The interest rate used to discount future cash flows to their present value. It reflects the time value of money and the opportunity cost of investing in one project over another.
4. Number of Periods (n): The length of time between today and the future date when the cash flow will occur, expressed in years, months, or other time units.

The equation is:

PV = FV / (1 + r)^n

Payback Period Calculation and Information:

Payback period is a capital budgeting method that measures how long it takes for an investment to generate enough cash flows to recover its initial cost.

Calculation:

1. Add up the expected cash flows for each period.
2. Begin counting periods from the initial investment until the cumulative cash flows equal or exceed the initial investment.
3. The payback period is the number of periods it takes to reach this point.

Information Provided:

• Indicates the time it takes to recoup the investment.
• Determines how quickly a project generates positive cash flows.
• Highlights potential risks associated with longer payback periods.
• Does not consider the time value of money or cash flows beyond the payback period.

Payback Criterion Decision Rule:

• Accept projects with a payback period shorter than a predetermined threshold (e.g., 3 years).
• Reject projects with payback periods exceeding the threshold.

Limitations:

• Ignores cash flows beyond the payback period, potentially underestimating long-term profitability.
• Doesn’t consider the time value of money, meaning cash flows received earlier are valued the same as those received later.