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    Evaluating A Single Project

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    Mahmoud Alswaiti
    The document discusses methods for evaluating the payback period of a single project, including the simple payback period which calculates the number of years for cash inflows to equal outflows without considering time value of money, and the discounted payback period which discounts cash flows at the MARR. It provides an example calculation of both methods and notes that payback periods of 3 years or less are often desired by US industry to assess riskiness.

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    Evaluating A Single Project

    Uploaded by

    Mahmoud Alswaiti
    14 views10 pages
    The document discusses methods for evaluating the payback period of a single project, including the simple payback period which calculates the number of years for cash inflows to equal outflows without considering time value of money, and the discounted payback period which discounts cash flows at the MARR. It provides an example calculation of both methods and notes that payback periods of 3 years or less are often desired by US industry to assess riskiness.

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    Evaluating a Single Project

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    The document discusses methods for evaluating the payback period of a single project, including the simple payback period which calculates the number of years for cash inflows to equal outflows without considering time value of money, and the discounted payback period which discounts cash flows at the MARR. It provides an example calculation of both methods and notes that payback periods of 3 years or less are often desired by US industry to assess riskiness.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    14 views10 pages

    Evaluating A Single Project

    Uploaded by

    Mahmoud Alswaiti
    The document discusses methods for evaluating the payback period of a single project, including the simple payback period which calculates the number of years for cash inflows to equal outflows without considering time value of money, and the discounted payback period which discounts cash flows at the MARR. It provides an example calculation of both methods and notes that payback periods of 3 years or less are often desired by US industry to assess riskiness.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 10

    Evaluating a Single Project

    The Payback (payout) period Method


    • All methods presented thus far reflect the profitability
    of a proposed alternative for a study of period N
    • It is a measure of liquidity rather than a measure of
    profitability.
    • liquidity deals with how fast an investment can be
    recovered
    • The payback method has been used as a measure of a
    project’s riskiness
    • A low-valued payback period is considered desirable.
    Evaluating a Single Project
    The simple payback period Method
    • There are two methods of payback period
    • The simple payback period ϴ calculates the
    number of years required for cash inflows to just
    equal cash outflows.
    • (ϴ ≤ N: study period)
    • The simple payback period,ϴ, ignores the time
    value of money and all cash flows occur after ϴ
    • i=0 %
    Example:
    Calculate the simple payback period ( ϴ)

    End of Year Net Cash Flow Cumulative PW at i=0%


    1 2 3
    0 -$25,000 -$25,000
    1 $8,000 25,000+ 8000 = -17,000

    2 $8,000 -17000 +8000 = -9,000

    3 $8,000 -9,000 + 8000 = -1000

    4 $8,000 -1000 + 8000 = +7000

    5 $13,000

    From the calculations ϴ = 4 years because the cumulative balance


    turns positive at EOY 4
    Evaluating a Single Project
    the discounted payback period method
    • The second method is the discounted payback
    period
    • The discounted payback period ϴ’ calculates the
    number of years required for cash inflows to just
    equal cash outflows.
    • (ϴ’ ≤ N: study period)
    • i’ is the MARR

    Done by Eng.Dana Salameh


    Example:
    Calculate the discounted payback period (ϴ’) at MARR=20%.

    PW of Cash flow at Cumulative PW at


    End of Year Net Cash Flow
    i=20% 20%
    1 2
    4 5
    0 -$25,000 -$25,000 -$25,000

    1 $8,000 8000/(1.2)1=6,667 -$18,333

    2 $8,000 8000/(1.2)2=5,556 -$12,777

    3 $8,000 8000/(1.2)3=4,630 -$8,147

    4 $8,000 8000/(1.2)4=3,858 -$4,289

    5 $13,000 13000/(1.2)5=5,223 $+934


    ϴ ' = 5 years because the cumulative discounted balance turns
    positive at EOY 5.
    Evaluating a Single Project
    The Payback (payout) period Method
    • Payback period of 3 years or less are often
    desired in U.S industry, so this project could be
    rejected, even though it is profitable
    (IRR=21.58%, PW=$934.29
    • The simple and discounted payback periods are
    graphically shown in figure

    Done by Eng.Dana Salameh


    Figure 5-9
    Evaluating a Single Project
    The Payback (payout) period Method
    • the simple payback and discounted payback
    period methods tell us how long it takes cash
    inflows from a project to accumulate to equal (or
    exceed ) the project cash outflows
    • The longer it takes to recover invested moneys,
    the greater is the perceived riskiness of a project
    • Recommendation: use the payback period only
    as supplemental information in conjunction with
    one or more of the other methods in this chapter.

    Done by Eng.Dana Salameh


    Evaluating a Single Project
    The Payback (payout) period Method
    • Example: a company plans to invest $14,000 in a
    system. The estimated cash outflows and inflows
    are shown below. What is the simple payback
    period for this proposed investment ?
    Expected cash flows EOY k
    10,000- 0
    4,000- 1
    3000 2-7
    12,000 8-12
    13,000 12

    Done by Eng.Dana Salameh


    Evaluating a Single Project
    The Payback (payout) period Method
    Cumulative net Expected cash EOY
    cash flow at i = flows
    0%
    -10,000 -10,000 0
    -14000 -4,000 1
    -11000 3000 2
    -8000 3000 3
    -5000 3000 4
    -2000 3000 5
    1000 3000 6
    The simple payback period is 6 years.
    Cash flows occur after the payback period are ignored
    The project’s liquidity is not very attractive

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