Most firms set a cut-off payback period, for example, three years depending on their business. In other words, in this example, if the payback comes in under three years, the firm would purchase the asset or invest in the project. If the payback took four years, it would not, because it exceeds the firm's target of a three-year payback period Pros/Cons of Payback Pros/Cons of Payback • The payback method is widely used by large firms to evaluate small projects and by small firms to evaluate most projects. • It is simple, intuitive, and considers cash flows rather than accounting profits. • The appropriate target payback period is subjectively determined. • Fails to assess whether a project adds value to the firm The payback period is the cost of the investment divided by the annual cash flow. The shorter the payback, the more desirable the investment. Conversely, the longer the payback, the less desirable.. The payback period refers to the amount of time it takes to recover the cost of an investment. Moreover, it's how long it takes for the cash flow of income from the investment to equal its initial.
If the payback period of a project is shorter than or equal to the management's maximum desired payback period, the project is accepted, otherwise rejected. For example, if a company wants to recoup the cost of a machine within 5 years of purchase, the maximum desired payback period of the company would be 5 years A project with shorter payback period implies higher returns. Numerous companies have maximum acceptable payback period however when they decide on which investment to go with, they will consider projects with less payback period than them. So, what are the advantages and disadvantages of payback period? Advantages Of Payback Period This does not mean that the respective payback period is 2-3 and 4-6 years, respectively. What it does mean is that the implied (pretax) required return for an investment in a small business is between 33% and 50% and between 16%-25% for investments in medium businesses If the payback period is greater than the maximum acceptable payback period, management should be indifferent. b. If the payback period is less than the maximum acceptable payback period, accept the project. Comparing net present value and internal rate of return _____. Select one
D) If the payback period is greater than the maximum acceptable payback period, management should be indifferent. C What is the payback period for Tangshan Mining company's new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2. The length of the maximum acceptable payback period is determined by management. This value is set subjectively on the basis of a number of factors, including the type of project (expansion, replacement or renewal, other), the perceived risk of the project, and the perceived relationship between the payback period and the share value The Payback Period The Payback Method Helps Firms Establish And Identify A Maximum Acceptable Payback Period That Helps In Capital Budgeting Decisions. There Are Two Versions Of The Payback Method: The Conventional Payback Method And The Discounted Payback Method. Consider The Following Case: Fuzzy Button Clothing Company Is A Small Firm, And.
Year 1 Year 2 Year o -$6,000,000 Year 3 $2,100,000 $2,400,000 Expected cash flow Cumulative cash flow Conventional payback period: $5,100,000 $ years The conventional payback period ignores the time value of money, and this concerns Cold Goose's CFO What Is an Acceptable Payback Period? The shortest payback period is generally considered to be the most acceptable. This is a particularly good rule to follow when a company is deciding between one or more projects or investments. The reason being, the longer the money is tied up, the less opportunity there is to invest it elsewhere
The two different ways of determining the maximum acceptable payback period shown in Fig. 1 are: (3) PP fy max =B years (B is a constant, index fy for fixed year PP) (4) PP hl max =L/2 years (index hl for half life PP) Looking at the minimum annual cash flows in each case you will find: (5) CF fy min =I/B (6) CF hl min =I/0.5L Accounting Q&A Library he payback method helps firms establish and identify a maximum acceptable payback period that helps in capital budgeting decisions. There are two versions of the payback method: the conventional payback method and the discounted payback method. Consider the following case: Green Caterpillar Garden Supplies Inc. is a small firm, and several of its managers are worried.
Decision criteria: - The length of the maximum acceptable payback period is determined by management. - If the payback period is less than the maximum acceptable payback period, accept the project. - If the payback period is greater than the maximum acceptable payback period, reject the project. © 2012 Pearson Prentice Hall Show transcribed image text The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Beta's. If the payback period is greater than the maximum acceptable payback period, then the project is rejected. Example. A software company will invest in projects if their payback period is less than 3 years. Project A has a payback period of 5 years. It fails the payback period rule and the company does not invest The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta's expected future cash flows
Payback period in capital budgeting refers to the time required to recoup the funds expended in an investment, or to reach the break-even point. For example, a $1000 investment made at the start of year 1 which returned $500 at the end of year 1 and year 2 respectively would have a two-year payback period Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones
Then, payback period is between 2 and 3 years, and can be approximated to be 2.6 years assuming uniform cash flows. Usually, a maximum acceptable payback period is set - projects that payback their initial investment sooner than the maximum are accepted, whereas projects that do not are rejected Payback period is a investment appraisal technique which tells the amount of time taken by the investment to recover the initial investment or principal. The calculation of payback period is very simple and its interpretation too. The advantage is its simplicity whereas there are two major disadvantage of this method If the payback period is greater than the maximum acceptable payback period, reject the project. Net Present Value (NPV) is a sophisticated capital budgeting technique; found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital When people ask about the payback period their intended question is When will I get my money back? In order to answer this question, the payback period must deal with cash flows — e.g., invest € 100 today, receive € 20 in year 1, € 30 in year 2 and € 50 in year 3 and the payback period is equal to three years
Payback Period = 3 + 11/19 = 3 + 0.58 ≈ 3.6 years. Decision Rule. The longer the payback period of a project, the higher the risk. Between mutually exclusive projects having similar return, the decision should be to invest in the project having the shortest payback period.. When deciding whether to invest in a project or when comparing projects having different returns, a decision based on. Fin/486 Week Three Individual Problems P10-2 Payback comparisons Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of $14,000 and generates annual after-tax cash inflows of $3,000 for each of the next 7 years If a project s payback period is less than the maximum acceptable payback period that the firm will accept, does this mean that the project's Net Present Value will also be positive? Explain
Payback period is widely used when long-term cash flows are difficult to forecast, because no information is required beyond the break-even point. It may be used for preliminary evaluation or as a project screening device for high risk projects in times of uncertainty. Payback period is usually measured as the time from the start of production to recovery of the capital investment In addition, although the payback method indicates the maximum acceptable period of the investment, it doesn't take into consideration any probabilities that may occur after the payback period, nor does it measure total incomes. It doesn't indicate whether purchases will yield positive profits over time The decision rule for the payback approach is generally based on a subjective maximum acceptable payback period set by management. If the project's payback period is less than (or equal to) the maximum acceptable payback period, accept the project
The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment. Only Machine 1 has a payback faster than 5 years and is acceptable. c. The firm will accept the first machine because the payback period of 4 years, 8 months is less than the 5-year maximum payback required by Nova Products. d. Machine 2 has returns that last 20 years while Machine 1 has only seven years of returns • The maximum acceptable payback period is determined by management. • If the payback period is less than the maximum acceptable payback period, accept the project. • If the payback period is greater than the maximum acceptable payback period, reject the project.. The payback period The payback method helps firms establish and Identify a maximum acceptable payback perlod that helps In their capltal budqeting declslons. f Cute Camel Woodcraft Company: Consider the case A- Cute Camel Woodcraft Company Is a small firm, and several of Its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta's. Payback comparisons Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of $14,000 and generates annual after-tax cash inflows of $3,000 for each of the next 7 years
jordan enterprises is considering a capital expenditure that requires an initial investment of 42,000 and returns after tax cash inflows of 7,000 per year for 10 years, the firm has a maximum acceptable payback period of 8 years a. determine the payback period for this project b. should the company accept the project?why or why not next question is calculate the net present value for the. Decision criteria: ∗ The length of the maximum acceptable payback period is determined by management. ∗ If the payback period is less than the maximum acceptable payback period, accept the project. ∗ If the payback period is greater than the maximum acceptable payback period, reject the project. 10-12 13. Payback Period (cont. The fixation of payback period is generally done by taking into account the, reciprocal of the cost of capital. For example- if the cost of capital is 20%, the maximum acceptable payback period would be fixed at 5 years (ii) In the case of mutually exclusive projects, pay back can be used as a ranking method For a firm not subject to a capital rationing restraint, if an independent project's discounted payback period is less than some maximum acceptable discounted payback period, the project would be accepted; if not, it would be rejected
5.3 Use the method to find if a project recovers its investment cost and other accrued costs within its service life or within a specified maximum acceptable payback period (MAPP) less than its service life. It is important to note that the decision to use the payback method should be made with care. (See Section 11 on Limitations. Decision criteria: The length of the maximum acceptable payback period is determined by management. If the payback period is less than the maximum acceptable payback period, accept the project. If the payback period is greater than the maximum acceptable payback period, reject the project. Nichelle 12
If the project's payback period is greater than the maximum acceptable payback period, reject the project; The Accounting Rate of Return (ARR) Method; This method of feasibility study involves estimating the accounting rate of return that a project should yield. If it exceeds a target rate of return then the project is acceptable iiskff-E Payback comparisons Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of $14,000 and generates annual after-tax cash inflows of $3,000 for each of the next 7 years Payback period Jordan Enterprises is considering a capital expenditure that requires an initial investment of $42,000 and returns after-tax cash inflows of $7,000 per year for 10 years. The firm has a maximum acceptable payback period of 8 years
A) Yes, since the payback period of the project is less than the maximum acceptable payback period. B) No, since the payback period of the project is more than the maximum acceptable payback period. C) Yes, since the risk exposure of the project is less than the maximum acceptable risk exposure Payback Period. Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them, by evaluating the associated risk C) If the payback period is greater than the maximum acceptable payback period, reject the project. D) Two of the above. 30) What is the payback period for Tangshan Mining company's new project if its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2. So the project is acceptable according to simple payback period method because the recovery period under this method (2.5 years) is less than the maximum desired payback period of the management (3 years). 2. Discounted payback period. The discounted payback method takes into account the present value of cash flows The payback method helps firms establish and identify a maximum acceptable wyback period that helps in their capital budgeting decisions. Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initiativestment from Project Omega's expected future cash flows
Investment A has a payback of 2.3 years while investment B returns the full value of its investment by the end of year 4. Since the firm's maximum payback period is 4 years, both investments are acceptable. However if only one can be chosen the firm should choose investment A because it recovers its investment more quickly than investment B Company management typically sets a maximum acceptable payback period as one of the evaluation techniques for capital projects. The payback period method ignores three important things: inflows that occur after the payback period has been reached; the company's desired rate of return; and the time value of money
Payback Period The payback method is the amount of time required for a firm to recover its initial investment in a project, as calculated from cash inflows. Decision criteria: - The length of the maximum acceptable payback period is determined by management. - If the payback period is less than the maximum acceptable payback period, accept. The payback period, one of the simplest and most frequently used methods of analysis, is the time it takes the firm to recover the initial investment from the earnings produced from the investment. The decision-maker arbitrarily sets some maximum acceptable payback period for different types of investments (land, buildings, equipment In general, the payback period depends on many Larsen et al. (2012) presented a snapshot of the ESCO industry in the USA, reporting that the median payback period varies from seven to ten years. jordan enterprises is considering a capital expenditure that requires an initial investment of 42,000 and returns after tax cash inflows of 7,000 per year for 10 years, the firm has a maximum acceptable payback period of 8 year