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.
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 Inflows (Rupees) | New Cash inflow from bailout (Sale of Equipment) (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 | Annual Cash Inflows (Rupees) | Cumulative Cash Flow (Rupees) |
|---|---|---|
| Year 0 | (250,000) | (250,000) |
| Year 1 | 90,000 | (160,000) |
| Year 2 | 95,000 | (65,000) |
| Year 3 | 65,000 | NIL |
[mkd_highlight background_color=”” color=”green” padding=”” line_height=”” font_size=”17″]Payback period is 3 years.[/mkd_highlight]
Whereas bailout payback period is as follows:
| Year | Annual Cash Inflows (Rupees) | Cumulative Cash Flow (Rupees) | Bailout Cash (sale of equipment) (Rupees) | Cumulative position with Bailout (Rupees) |
|---|---|---|---|---|
| Year 0 | (250,000) | (250,000) | ||
| Year 1 | 90,000 | (160,000) | 100,000 | (60,000) |
| Year 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:
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