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tannyye wrote:Sir, I appreciate the fact that your answer are similar to model answers from ACCA. I also appreciate the fact that the theory behind Macaulay Duration caused the formula to make an average that reflects different payouts. What I dont appreciate, or dont understand, however, is the statement that “duration, measures the average time required to recover the initial investment if discounted at IRR or the present value of the project if discounted at cost of capital.” due to the fact that the payout at the produced average time always ranged between 50% and 100% of the initial investment or present value of the project. We will never receive an exact 100% payback at that time weighted average period. This is because the difference between the discounted payback at irr and duration using irr, is being reflected as the bulk cash flow paid in which period. The duration method sacrificed accuracy to show that a project that pays its bulk cashflow upfront is better. While it accounts for the bulk cashflow upfront and the cashflow after the payback period, it also ignores whether 100% of the initial investment have been paid back. It even ignores how much was invested to initiate the project. My understanding is that we should use both methods hand in hand to not just determine the project with the best liquidity but to also have the extra knowledge when we can EXACTLY get back our initial investment assuming other assumptions are correct.
P.S. I realize the payback methods may only be applicable to projects. We know the payback period of bonds, it is always the last year.
Sir, I appreciate the fact that your answer are similar to model answers from ACCA. I also appreciate the fact that the theory behind Macaulay Duration caused the formula to make an average that reflects different payouts. What I dont appreciate, or dont understand, however, is the statement that “duration, measures the average time required to recover the initial investment if discounted at IRR or the present value of the project if discounted at cost of capital.” due to the fact that the payout at the produced average time always ranged between 50% and 100% of the initial investment or present value of the project. We will never receive an exact 100% payback at that time weighted average period. This is because the difference between the discounted payback at irr and duration using irr, is being reflected as the bulk cash flow paid in which period. The duration method sacrificed accuracy to show that a project that pays its bulk cashflow upfront is better. While it accounts for the bulk cashflow upfront and the cashflow after the payback period, it also ignores whether 100% of the initial investment have been paid back. It even ignores how much was invested to initiate the project. My understanding is that we should use both methods hand in hand to not just determine the project with the best liquidity but to also have the extra knowledge when we can EXACTLY get back our initial investment assuming other assumptions are correct.
Thus I conclude that the statement produced by ACCA is not entirely correct. And I would advise that we should state the advantages and disadvantages of both methods clearly, otherwise when we are working, we might potentially mislead others who dont really understand the duration method either.
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