PAYBACK PERIOD

Annuity:

Mixed Stream:
 PAYBACK PERIOD
Decision criteria:

Payback Maximum
Acceptable =
Period
Period
 PAYBACK PERIOD
Decision criteria:

Payback Maximum
Acceptable =
Period
Period
 PAYBACK PERIOD
Factors in setting maximum acceptable payback period:

Type of project

Product life cycle

Perceived risk of the project
Perceived relationship between the payback
period and the share value

It is the value that management feels, on average, will result in value-creating

investment decision
 PAYBACK PERIOD
Example 10.1
 PAYBACK PERIOD
PROS CONS

Computational simplicity and intuitive × It is merely a subjectively determined

appeal number
It gives implicit consideration to the
timing of cash flows

Measure risk exposure

 PAYBACK PERIOD
Example 10.2

Seema Medhi is considering investing $20,000 to obtain a 5% interest in a

rental property. Her good friend and real estate agent, Akbar Ahmed, put the
deal together and he conservatively estimates that Seema should receive
between $4,000 and $6,000 per year in cash from her 5% interest in the
property. The deal is structured in a way that forces all investors to maintain
their investment in the property for at least 10 years. Seema expect to remain
in the 25% income-tax bracket for quite a while. To be acceptable, Seema
requires the investment to pay itself bck in terms of after-tax cash flows in less
than 7 years.
 PAYBACK PERIOD
Example 10.2

Seema’s calculation of the payback period on this deal begins with calculation
of the range of annual after-tax cash flow:

After-tax cash flow = (1-tax rate) x pre-tax cash flow

= (1-0.25) x $4,000 = $3,000
= (1-0.25) x $6,000 = $4,500

payback period = Initial investment / After-tax cash flow

= $20,000 / $3,000 = 6.67 years
= $20,000 / $4,500 = 4.44 years
 PAYBACK PERIOD
PROS CONS

Computational simplicity and intuitive × It is merely a subjectively determined

appeal number
It gives implicit consideration to the × It fails to take fully into account the
timing of cash flows time factor in the value of money

Measure risk exposure

 PAYBACK PERIOD
Example 10.3

DeYarma Enterprises, a small medical appliance manufacturer, is considering

two mutually exclusive projects named Gold and Silver. The firm uses only the
payback period to choose projects. The cash flows and payback period for each
project are given in the table.
 PAYBACK PERIOD
PROS CONS

Computational simplicity and intuitive × It is merely a subjectively determined

appeal number
It gives implicit consideration to the × It fails to take fully into account the
timing of cash flows time factor in the value of money

Measure risk exposure × It fails to recognize cash flows that

occur after the payback period.
 PAYBACK PERIOD
Example 10.4

Rashid Company, a software developer, has two investment opportunities, X

and Y. Data for project X and y are given below.
 PAYBACK PERIOD
PROS CONS

Computational simplicity and intuitive × It is merely a subjectively determined

appeal number
It gives implicit consideration to the × It fails to take fully into account the
timing of cash flows time factor in the value of money

Measure risk exposure × It fails to recognize cash flows that

occur after the payback period.
THANK YOU