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Bailout Payback Period

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Bailout Payback Period

Bailout payback period
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Introduction 

The bailout payback period considers the time period within which cumulative cash flows are generated by the project after adding cashflows generation from the sale of equipment.

Bailout cash flows are the estimates of cash flows inflows that shall arise on sale of equipment at the end of the project or cash out flows that shall be the estimated cost required at the time closure of project.

The cash inflows from the sale of equipment reduces / falls every year. Hence, the disposal amount received in year 4 for example shall be lower than amount received in year 3.

Decision Rule:

A maximum payback period of the project is determined by the company.

If expected payback period from the project is within the period determined by the company, the project is accepted and vice versa.

For more than one projects, the quickest payback period achieving project is selected.

 

Bailout Payback period explained with example

A company is considering a new project with initial investment of Rs.200,000 on equipment and working capital of Rs.50,000. The project is expected to earn return of below net cash receipts:

Year Annual Cash inflow Rupees New Cash inflow from bailout Rupees
Year 1 90,000 100,000
Year 2 95,000 65,000
Year 3 65,000 30,000
Year 4 20,000 Nil

Answer:

The Payback period without bailout is as follows:

At year 0 there is investment of Rs.250,000 (investment plus working capital Rs.200,000+Rs.50,000).

Year

Cash flow

Cumulative Cash flow

0

(250,000)

(250,000)

1

90,000

(160,000)

2

95,000

(65,000)

3

65,000

Nil

Payback period is 3 years.

Whereas bailout payback period is as follows:

Year Cash flow Cumulative Cash flow Bailout Cash Cumulative position with Bailout
0 (250,000) (250,000)    
1 90,000 (160,000) 100,000 (60,000)
2 95,000 (65,000) 65,000 5,000

 

After considering the bailout the payback period has been reduced from 3 years to 2 years.

Audience:

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

Advance topics on payback period:

Payback period

Discounted payback period

Ali Murtaza

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