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    Pay Back

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    Keerthi Prem
    The payback period method calculates the number of years required to recover the original investment cost of a project from its annual net cash inflows. It is computed by dividing the initial investment by the average annual net cash inflow. The payback period serves as a screening tool, identifying projects that recoup investments quickly. However, it ignores the time value of money and cash flows occurring after the payback period.

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    Pay Back

    Uploaded by

    Keerthi Prem
    15 views11 pages
    The payback period method calculates the number of years required to recover the original investment cost of a project from its annual net cash inflows. It is computed by dividing the initial investment by the average annual net cash inflow. The payback period serves as a screening tool, identifying projects that recoup investments quickly. However, it ignores the time value of money and cash flows occurring after the payback period.

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    Pay Back

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    The payback period method calculates the number of years required to recover the original investment cost of a project from its annual net cash inflows. It is computed by dividing the initial investment by the average annual net cash inflow. The payback period serves as a screening tool, identifying projects that recoup investments quickly. However, it ignores the time value of money and cash flows occurring after the payback period.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    15 views11 pages

    Pay Back

    Uploaded by

    Keerthi Prem
    The payback period method calculates the number of years required to recover the original investment cost of a project from its annual net cash inflows. It is computed by dividing the initial investment by the average annual net cash inflow. The payback period serves as a screening tool, identifying projects that recoup investments quickly. However, it ignores the time value of money and cash flows occurring after the payback period.

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    Pay Back Period Method

    Payback period method


    • Payback period is defined as the number of years required to recover
    the original cash investment.
    • It is the period of time at the end of which a machine, facility, or other
    investment has produced sufficient net revenue to recover its
    investment costs.
    The Payback Method
    The payback period is the length of time that it
    takes for a project to recover its initial cost out
    of the cash receipts that it generates.

    When the annual net cash inflow is the same


    each year, this formula can be used to compute
    the payback period:
    Investment required
    Payback period =
    Annual net cash inflow
    The Payback Method
    Management at The Daily Grind wants to install an
    espresso bar in its restaurant that
    1. Costs $140,000 and has a 10-year life.
    2. Will generate annual net cash inflows of
    $35,000.

    Management requires a payback period of 5 years


    or less on all investments.

    What is the payback period for the espresso bar?


    The Payback Method
    Investment required
    Payback period =
    Annual net cash inflow

    $140,000
    Payback period = $35,000

    Payback period = 4.0 years

    According to the company’s criterion,


    management would invest in the espresso bar
    because its payback period is less than 5 years.
    Quick Check 
    Consider the following two investments:
    Project X Project Y
    Initial investment $100,000 $100,000
    Year 1 cash inflow $60,000 $60,000
    Year 2 cash inflow $40,000 $35,000
    Year 14-10 cash inflows $0 $25,000
    Which project has the shortest payback period?
    a. Project X
    b. Project Y
    c. Cannot be determined
    Quick Check 
    Consider the following two investments:
    Project X Project Y
    Initial investment $100,000 $100,000
    Year 1 cash inflow $60,000 $60,000
    Year 2 cash inflow $40,000 $35,000
    Year 14-10 cash inflows $0 $25,000
    Which project has the shortest payback period?
    a. Project X
    b. Project Y
    c. Cannot be determined
    •Project X has a payback period of 2 years.
    •Project Y has a payback period of slightly more than 2 years.
    •Which project do you think is better?
    Evaluation of the Payback Method
    Ignores the
    time value
    of money.

    Short-comings
    of the payback
    period. Ignores cash
    flows after
    the payback
    period.
    Evaluation of the Payback Method
    Serves as
    screening
    tool.
    Identifies
    Strengths investments that
    of the payback recoup cash
    period. investments
    quickly.
    Identifies
    products that
    recoup initial
    investment
    quickly.
    Payback and Uneven Cash Flows
    When the cash flows associated with an
    investment project change from year to year,
    the payback formula introduced earlier cannot
    be used.
    Instead, the un-recovered investment must be
    tracked year by year.
    $1,000 $0 $2,000 $1,000 $500

    1 2 3 4 5
    Payback and Uneven Cash Flows

    For example, if a project requires an initial


    investment of $4,000 and provides uneven net
    cash inflows in years 1-5 as shown, the
    investment would be fully recovered in year 4.

    $1,000 $0 $2,000 $1,000 $500

    1 2 3 4 5

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