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How to calculate payback period?

Mahalaxmi (job seeker) (1198 Points)

06 July 2013

please anybody tell me details about how to calculate pay back period ?from the following details:

project A project B

year pv of cash inflows cumulative pv pv of cf cumulative pv

1 ------- -------- 51720 51720

2 22290 22290 62412 114132

3 84612 106902 61536 175668

4 46368 153270 56304 231972

5 39984 193254 42840 274812

calculate discounted pay back period of project A and project B ?

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16 Replies

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

Hi,
How much is the initial investment / Project cost ?

Mahalaxmi (job seeker) (1198 Points)
Replied 06 July 2013

initial investment of two project 135000 & 240000.

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

Payback period is the period within which the cash inflow are paid off the cash outflows. In simple terms, it is getting back the capital amount invested. This payback period indicates within what time the investment is paid off (recovered).

2 approaches for calculating pay back period

1. For equal cash flows

2. For unequal cash flows

Equal cash flows - The formula is simple in this case.

Pay back period = Initial investment / Equal cash flows

Unequal cash flow - There are few steps involved in calculating the same

Step 1 : With the unequal cash flows, compute cumulative cash flow

Step 2 : With the cumulative cash flow computed, compare the initial investment amount, Wherein the ranging years with which the amount can be recovered can be examined. (for eg 2-3 yrs)

Step 3 : Formula for payback period is Base year + (required difference/cumulative cash flow of the ranging years arrived above)

Eg: The ranging years is 2-3 years. Initial investment is Rs 1,50,000 and the 2nd & 3rd years cumulative cash flow is 1,10,000 and 1,90,000

Then ,
> The base year here is 2 years.
> Required difference is difference of lower range and initial investment ie(1.5 lakhs - 1.1 lakhs)
> cumulative cash flows of ranging year is 1.9 lakhs - 1.1 lakhs

To sum up , 2 years + ( 1.5-1.1 lakhs/1.9-1.1lakhs) = 2 years and 6 months.

Appy the second method for the above problem.

Thanks.

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

Work out the problem with the second approach.

Hope you are clear.

Mahalaxmi (job seeker) (1198 Points)
Replied 06 July 2013

if ranging year is 1 to 5 how i select base year..

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

See, in Project A the range is 3-4 years and Project B it is 4-5 years.
Kindly compare the cumulative cash flows with initial investment for the range.

Is it fine now ?

Mahalaxmi (job seeker) (1198 Points)
Replied 06 July 2013

is it same payback period and discounted pay back period?

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

Is any discounting rate given in the problem? If yes, then discount the cash flows and then arrive at the cumulative cash flow.

Mahalaxmi (job seeker) (1198 Points)
Replied 06 July 2013

i cannot done my above given problem.answer for disc payback of project a is 3.606 yrs and project b is 4.187 yrs.

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

Well, That is the correct answer and it can be done.

Pay back period of Project A = 3 years + (135000-106902)/ (153270-106902) which gives an answer of 3.605978 years.

Likewise compute for Project B.

Mahalaxmi (job seeker) (1198 Points)
Replied 06 July 2013

if 0 to 5 yrs then base year is ?

Ayyswariya RG (Knowledge Seeker) (3711 Points)
Replied 06 July 2013

Where is it 0-5 years? It is not in the present problem and the situation like that is not possible. Either it can be 0-1 or 4-5. The nearest range possible