PAYBACK METHOD

Hope you have got clue from word payback. Actually this method tells about minimum time to recover at least investment cost. Every investor wants to know about minimum time in which he can recover at least cost of investment so as to maximize profit time after that period.

 

 

 

For constant CASHFLOWS (CF’s) Payback time = initial investment /annual cash flow

 

For Uneven CASHFLOWS (CF’s) Payback time is calculated by commutative cash flows, easy way is to draw 3 columnar tables to work out payback time

 

TIME

CASHFLOW($)

COMMULATIVE CASH FLOW

 

0

(X)

(X)

 

1

X

(X)

 

2

X

(X)

 

3

X

XX

 

 

 

 

Decision Clue

Compare calculated payback period with target one given. If it is less than target payback period then accept to invest in project and vice versa

 

 

 

 

EXAMPLE

PV Co is evaluating an investment proposal to manufacture Product W33, which has performed well in test marketing trials conducted recently by the company’s research and development division. The following information relating to this investment proposal has now been prepared.

 

Year 1 2 3 4

 

Demand (units) 60,000 70,000 120,000 45,000

 

Cashflows($) 509,040 574,919 1014,130 268,333

 

Initial investment in $2 million.It

 

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