Question on Payback Period
I am confused if I consider pay back period from the begening or only after proejct is completed.
Abhishek notes say we should consider the time of completion.
For example, a project to replace an outmoded process is expected to cost $80,000 and require $10,000 a year to maintain. But it’s expected to result in a $50,000 annual savings. The payback period for this project will be two years. When calculating a payback period, keep in mind how long the project will take. In the example below, if the project requires one year to be completed, the payback period would be three years instead of two.
On contrast in one of the website it was mentioned we should NOT consider it
- Pay back period - Project cost 4,800,000 and will take 3 years to complete. It will make a return per year of $800,000 after completion. What is the pay back period? 6 or 9 year.---- Ie 4800000 / 800000 = 6 years. ie . Should I consider pay back period from now or only after 3 years of completion. If I consider from start date of the project it will be 9 years. What should be right answer 6 yrs or 9 years
Answer posted was:
http://en.wikipedia.org/wiki/Payback_period
Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment. For example, a $1000 investment which returned $500 per year would have a two year payback period.6 years is the right answer
sspawar
Mon, 01/07/2013 - 06:57
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Quite iteresting wikipedia
Quite iteresting
wikipedia this part is more important : it is saying the same as abhishek
Payback period is usually expressed in years. Start by calculating Net Cash Flow for each year: Net Cash Flow Year 1 = Cash Inflow Year 1 - Cash Outflow Year 1. Then Cumulative Cash Flow = (Net Cash Flow Year 1 + Net Cash Flow Year 2 + Net Cash Flow Year 3 ... etc.) Accumulate by year until Cumulative Cash Flow is a positive number: that year is the payback year.
To calculate a more exact payback period: Payback Period = Amount to be Invested/Estimated Annual Net Cash Flow 1{[1]}
Additional complexity arises when the cash flow changes sign several times; i.e., it contains outflows in the midst or at the end of the project lifetime. The modified payback period algorithm may be applied then. First, the sum of all of the cash outflows is calculated. Then the cumulative positive cash flows are determined for each period. The modified paybackis calculated as the moment in which the cumulative positive cash flow exceeds the total cash outflow.
see this thread in support
http://www.business-case-analysis.com/payback-period.html
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Generally in A project --- investments evolve in early years with 0 inflows. And when inflows evolves, little outflows evolve.
Thus you have to consider - from start point of time of investment.
it is drawback that it does not have impact of amount of netflow wrt to timeline, while comparing two opportunities ( alternates).
mhk
Mon, 01/07/2013 - 09:10
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payback period is
payback period is the time required to reach break even. So it is the time when the
investment=returns, however till the project is completed the returns dont come in and payback period is calculated after the project completes.
the project duration does not come in payback period. because the investment is also not done at one go and is done in phased manner.
the budget may be earmarked for the project but it is not spent till it is required by the project.
hence you do not consider the project duration in payback period.