1. A
Presentation
on
Payback Method
Guided By: Prepared By:
Prof. Pinakin Jaiswal Bhumi Thakkar (31)
Jaimeen Panchal(32)
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2. CAPITAL BUDGETING
• The term 'Capital Budgeting' refers to long term planning for
proposed capital outlays & their financing.
• Capital budgeting is a process by which organization evaluates and
selects long-term investment projects
– Ex. Investments in capital equipment, purchase or lease of
buildings, purchase or lease of vehicles, etc.
• There are various techniques(methods) used to make capital budgeting
decisions.
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3. CAPITAL BUDGETING
Outcome Large amounts of
is uncertain. money involved.
Analyzing alternative long-
term investments and deciding
which assets to acquire or sell.
Decision may be
Investment involves
difficult or impossible
long-term commitment.
to reverse. #

4. Capital Budgeting Appraisal
Methods
1. TRADITIONAL METHOD
A. Pay back method
B. Average rate o return
2. TIME-ADJUSTED METHOD
A. Net present value method
B. Internal rate of return
C. Profitability index method
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5. Pay-back method:
Payback (period) Method is the exact amount of time required for a
firm to recover its initial investment in a project as calculated from
cash inflows.
Or
In other words, the payback period is the length of time required to
recover the initial cost of the project.

6. E.g. If a project requires Rs. 20,000 as initial investment and it
will generate an annual cash inflows of Rs 5000 for 10yrs the
pay-back will be 4 years.
Payback period = Initial investment
Constant Annual cash inflow
= 20000/5000
= 4 years
Unadjusted rate of return = Annual return * 100
Initial investment
= 5000 /20000 *100
= 25%

7. When the annual cash inflows
are un equal:
E.g. a proposal requires a cash outflow of Rs. 20,000
and is expected to generate cash inflow of Rs 8000,Rs
6000, Rs 4000, Rs 2,000 Rs 2,000 over next 5 years
The payback period = 4
as the sum of cash inflow is 20,000
Year Annual CF Cumulative CF
1 8,000 8,000
2 6,000 14,000
3 4,000 18,000
4 2,000 20,000

8. Payback Period –
Uneven Cash Flows
Cumulative
Casey Co. wants to Annual Net Net Cash
install a machine Year Cash Flows Flows
that costs 16,000 0 (16,000) (16,000)
and has an 8-year 1 3,000 (13,000)
useful life with zero 2 4,000 (9,000)
salvage value. 3 4,000 (5,000)
Annual net cash 4 4,000 (1,000)
5 5,000
flows are:
6 3,000
7 2,000
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9. Payback Period –
Uneven Cash Flows
Cumulative
We recover the 16,000 Annual Net Net Cash
purchase price between Year Cash Flows Flows
years 4 and 5, about 0 (16,000) (16,000)
4.2 years for the 1 3,000 (13,000)
payback period. 2 4,000 (9,000)
3 4,000 (5,000)
4 4,000 (1,000)
4.2
5 5,000
6 3,000
7 2,000
8 2,000
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10. ACCEPT-REJECT CRITERIA
• The pay back period can be used as a decision criterion to
accept or reject investment proposals.
• Application of this technique is to compare the actual pay back
with a predetermined pay back.
• Actual pay back period is less than the predetermined pay back,
the project would be accepted; if not, it would be rejected.
• When mutually exclusive projects are under consideration, they
may be ranked according to the length of the pay back period.
• Thus, the project having the shortest pay back may be assigned
rank one, followed in that order so that the project with the
longest pay back would be ranked last. #

11. ADVANTAGES OF PAYBACK
METHOD
• Payback period method is simple and easy to calculate and to
apply fro small, repetitive investments.
• It gives the indication of liquidity. In case a firm is having liquidity
problem, this method is good to adopt as it emphasizes earlier cash
inflows.
• It deals with risk too. The project with a shorter payback period will
be less risky as compared to project with a longer payback period.
• Payback period method takes into account tax and depreciation.
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12. DISADVANTAG OF PAYBACK
METHOD
• It ignores the time value of money.
e.g. There are 2 projects a and b , the cost of project is 30,000 in
each case. The cash inflows are as :
Year Project A Project B
1 10,000 2,000
2 10,000 4,000
3 10,000 24,000
• It completely ignores all cash inflows after the payback period.
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13. NET PRESENT VALUE (NPV)
• Net Present Value (NPV), defined as the present value of the future
net cash flows from an investment project, is one of the main ways to
evaluate an investment.
• When choosing between competiting investments using the net present
value calculation you should select the one with the highest present
value.
If:
NPV > 0, accept the investment.
NPV < 0, reject the investment.
NPV = 0, the investment is marginal
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14. NPV V/S PAYBACK PERIOD
• NPV (Net Present Value) is calculated in terms of currency while
Payback method refers to the period of time required for the return on
an investment to repay the total initial investment.
• NPV, payback, and many other measurements form a number of
solutions to evaluate project value.
• Payback method, v/s NPV method, has limitations for its use because it
does not properly account for the time value of money, inflation, risk,
financing or other important considerations.
• While NPV method considers time value and it gives a direct measure
of the dollar benefit on a present value basis of the project to the firm’s
shareholders. NPV is the best single measure of profitability.
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15. • Payback, v/s NPV, ignores any benefits that occur after the payback
period. It also does not measure total incomes.
• An implicit assumption in the use of payback period is that returns to
the investment continue after payback period.
• Payback method does not specify any required comparison to other
investments or investment decision making.
• It indicates the maximum acceptable period for the investment. While
NPV measures the total value of project benefits. NPV, payback period
fully considered, is the better way to compare with different investment
projects.
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