Payback Period(PBP) 0 3 5 40K 10K 12K 15K 10K 7K PBP is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow 13-6
13-6 Payback Period (PBP) PBP is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow. 0 1 2 3 4 5 -40 K 10 K 12 K 15 K 10 K 7 K
Payback Solution(1) 0 3(a) 5 40K(b)10K 12K 15K 10K(d)7K 10K 22K 37Kc)47K54K Cumulative Inflows PBP =a+(b-c)/d =3+(40-37)/10 =3+(3)/10 = 3.3 Years 13-7
13-7 10 K 22 K 37 K(c) 47 K 54 K Payback Solution (#1) PBP = a + ( b - c ) / d = 3 + (40 - 37) / 10 = 3 + (3) / 10 = 3.3 Years 0 1 2 3 4 5 -40 K 10 K 12 K 15 K 10 K 7 K Cumulative Inflows (a) (-b) (d)
Payback Solution(2) 0 3 5 40K 10K 12K 15K (10K 7 K 40K 30K -18K 3K 7K 14K PBP=3+(3K)/10K Cumulative = 3.3 Years Cash flows Note: Take absolute value of last negative cumulative cash flow 13-8 value
13-8 -40 K -30 K -18 K -3 K 7 K 14 K Payback Solution (#2) PBP = 3 + ( 3K ) / 10K = 3.3 Years Note: Take absolute value of last negative cumulative cash flow value. 0 1 2 3 4 5 -40 K 10 K 12 K 15 K 10 K 7 K Cumulative Cash Flows
PBP Acceptance Criterion The management of Basket Wonders has set a maximum pbp of 3 5 Years for projects of this type Should this project be accepted? Yes! The firm will receive back the initial cash outlay in less than 3.5 Years. [3.3 Years 3.5 Year Max 13-9
13-9 PBP Acceptance Criterion Yes! The firm will receive back the initial cash outlay in less than 3.5 Years. [3.3 Years < 3.5 Year Max.] The management of Basket Wonders has set a maximum PBP of 3.5 Years for projects of this type. Should this project be accepted?
PBP Strengths and Weaknesses Strengths Weaknesses o Easy to use and Does not account understand for Tvm Can be used as a Does not consider measure of cash flows beyond liquidity the PBP n Easier to forecast Cutoff period is ST than LT flows subjective 13-10
13-10 PBP Strengths and Weaknesses Strengths: Easy to use and understand Can be used as a measure of liquidity Easier to forecast ST than LT flows Weaknesses: Does not account for TVM Does not consider cash flows beyond the PBP Cutoff period is subjective