Professional Documents
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Formula
Computation Of Payback Period
When the cash inflows are uniform the formula for payback period is cash outflow
divided by annual cash inflow
The formula to calculate payback period of a project depends on whether the cash flow per
period from the project is even or uneven. In case they are even, the formula to calculate
payback period is:
Payback Period =
Initial Investment
Annual Cash Inflow
Payback Period = A +
B
C
Examples
Example 1: Even Cash Flows
Company C is planning to undertake a project requiring initial investment of $105 million.
The project is expected to generate $25 million per year for 7 years. Calculate the payback
period of the project.
Solution
Payback Period = Initial Investment Annual Cash Flow = $105M $25M = 4.2 years
Example 2: Even Cash Flows
A project costs Rs 2,00,000 and yields an annual cash inflow of Rs 40,000 for 8 years
Calculate Payback period
Initial Investment
Annual Cash Inflow
Payback Period =
=2,000,0000/40,000=5 years
Example 1: Uneven Cash Flows
5,000
5,000
10,000
15,000
15,000
30,000
20,000
50,000
25,000
75,000
30,000
1,05,000
2.
It can be a measure of risk inherent in a project. Since cash flows that occur later in
a project's life are considered more uncertain, payback period provides an indication of
how certain the project cash inflows are.
3.
For companies facing liquidity problems, it provides a good ranking of projects that
would return money early.
Payback period does not take into account the time value of money which is a
serious drawback since it can lead to wrong decisions. A variation of payback method
that attempts to remove this drawback is calleddiscounted payback period method.
2.
It does not take into account, the cash flows that occur after the payback period.
Year
0
Project A
(Rs.3,000)
B
(Rs.3,000)
C
(Rs.3,000)
D
(Rs.3,000)
300
300
600
2,700
600
900
300
900
900
1,500
-300
2,100
1,200
1,500
-1,200
3,900
3,750
1,800
Payback 2 yrs.
4 yrs.
4 yrs.
3 yrs.
The PV factor is greater for cash receipts scheduled for the near future, and smaller
for receipts that are not expected until a later date. The factor is always a number
less than one.
The formula for calculating the present value factor is:
P = (1 / (1 + r)n)
Where: