a

Facebook

Twitter

Copyright 2021 TheProReaders.
All Rights Reserved.

Facebook

Twitter

LinkedIn

Youtube

Menu
 

Discounted Payback Period

The Pro Readers > All Articles  > Discounted Payback Period

Discounted Payback Period

Spread Learning

The discounted payback period is calculated by the same way as payback period the only difference is that cash flows are converted into present value. It is the period before which the Present Value of cumulative cash flow becomes zero.

Example: Discounted Payback period with even annual cash flow (constant cashflow)

A company is considering a project with initial investment of Rs.700,000. The constant cash flows to be received from the project is Rs.200,000 for a period of 6 years. Discount Rate is 13%.

Answer:              

The discounted payback period shall be calculated as follows:

Year Cash Flow (Rs) Discount Factor (13%) PV of Cash Flow (Rs) Cumulative PV (Rs)
0 (700,000) 1 (700,000) (700,000)
1 200,000 0.884 176,800 (523,200)
2 200,000 0.783 156,600 (366,600)
3 200,000 0.693 138,600 (228,000)
4 200,000 0.613 122,600 (105,400)
5 200,000 0.542 108,400 3,000
6 200,000 0.480 96,000 99,000
NPV     99,000  

 

The discounted payback period is 4 years+ (105,400 / 108,400 = 0.97 x 12 = 11.64 months or 11 months and 19 days)

Days calculation = 0.64 months x 30 = 19 days

Or in terms of days it can be (105,400 / 108,400 = 0.97 x 365 = 354 days) = 4 years and 354 days.

Concept of discounting

How discount factor was calculated?

 

The discounted payback period is always longer than payback period because cash flows are discounted which reduces the inflows and increase the period within which investment shall be recovered.

 

Example: Payback period with uneven annual cash flow

A company is considering a project with initial investment of Rs.700,000. The cash flows to be received from the project are as follows for a period of 6 years. Discount Rate is 13%.

  • Y1 = Rs.75,000
  • Y2 = Rs.150,000
  • Y3 = Rs.265,000
  • Y4 = Rs.285,000                         
  • Y5 = Rs.291,500
  • Y6 = Rs.75,000

 

Answer:              

 

The discounted payback period shall be calculated as follows:

Year Cash Flow (Rs) Discount Factor (13%) PV of Cash Flow (Rs) Cumulative PV (Rs)
0 (700,000) 1 (700,000) (700,000)
1 75,000 0.884 66,300 (633,700)
2 150,000 0.783 117,450 (516,250)
3 265,000 0.693 183,645 (332,605)
4 285,000 0.613 174,705 (157,900)
5 291,500 0.542 157,993 93
6 75,000 0.480 36,000 36,093
NPV     36,093  

The discounted payback period is 5 years.

Advantages of Payback Period

  • Easy to understand and easy to calculate.
  • Based on cash flows of the project and not accounting profit.

Disadvantages of Payback Period

  • It is difficult to set minimum payback period due to its subjectivity.
  • It may cause selection of a project with earliest payback period then highest NPV of any other project.

Audience:

The article is for students to learn basic concept of payback period and for professionals so that they can revise the topic for usage in practical life. 

Advance topics on payback period:

 

Payback Period

Bailout payback period

Ali Murtaza

2 Comments

Leave a Comment