Zulfiqar Hasan
This example will enable you to calcualte and to take decision in capital budgeting. Payack Period (PBP), Net Present Value (NPV) and Profitability Index (PI) are calculated here for two projects.
Problem:
Use data from the following table and Calculate payback period of both projects if Target Payback Period is 2.9 Years. Whcih projects should be selected if they are Independent? If they are mutually exclusive?
Solutions:
a. We apply the following formula to calculate the Payback Period
a = Number of Year before Full recovery year
b = Initial investment
c. Cumulative cash flow at year "a"
d = Actual Cash Flow at full recovery Year
|
Project X |
|||||
|
|
0 |
1 |
2 (a) |
3 (Full Recovery Year) |
4 |
|
CF |
-10000 (b) |
6500 |
3000 |
3000 (d) |
1000 |
|
Cumulative Cash Flow |
|
6500 |
9500 (c) |
12500 |
13500 |
|
Project Y |
|||||
|
|
0 |
1 |
2 (a) |
3 (Full Recovery Year) |
4 |
|
|
-10000 |
3500 |
3500 |
3500 (d) |
3500 |
|
Cumulative Cash Flow |
|
3500 |
7000 (c) |
10500 |
14000 |
Payback Period of Project X:
= 2.17 Years
Payback Period of Project Y:
= 2.86 Years
Decision Under Payback Period:
Independent Project: As actual (calculated) payback period is lower than the Target Paback period in both projects, both project X and Project Y can be selected if they are independent.
Mutualy Exclusive Project: Project under lower payback period should be selected if they are mutually exclusive project. Here, Project X should be selected.
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