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Payback Period

The document explains how to calculate the payback period in financial management using an example with an initial cash outflow of Rs.100,000 and projected cash flows over four years. It outlines the steps to determine the cumulative cash inflows and compute the payback period, which in this case is 2.66 years. The source of the information is from 'Fundamentals of Financial Management' by James C. Van Horne and John M. Wachowicz, Jr.

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2 views2 pages

Payback Period

The document explains how to calculate the payback period in financial management using an example with an initial cash outflow of Rs.100,000 and projected cash flows over four years. It outlines the steps to determine the cumulative cash inflows and compute the payback period, which in this case is 2.66 years. The source of the information is from 'Fundamentals of Financial Management' by James C. Van Horne and John M. Wachowicz, Jr.

Uploaded by

waaseabdul5
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© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Payback Period Calculations

In order to get the complete understanding of the calculations regarding Payback


period (lecture # 08) in Financial Management, you must have to go through the
example given below. You may also practice the illustrations from reference and
recommended books.

Example

Initial cash outflow for the project is Rs.100,000 and project is expected to generate
net cash flows of Rs.34,432, Rs.39,530, Rs.39,359, and Rs.32,219 over the next 4
years.
Calculate payback period?

Solution:

Year Cash flows Cumulative cash


inflows
0 (Rs.100,000)
(b)
1 34,432 34,432
2 (a) 39,530 73,962 (c)
3 39,359 (d) 113,321
4 32,219 145,540

Payback period = a + (b-c)/d


= 2 + (100,000 - 73,962)/ 39,359
= 2 .66 years

Steps to calculate the Payback Period:

1. Accumulate the cash flows occurring after the initial investment in a “cumulative
inflows” column
2. Look at the “cumulative inflows” column and note the last year (a whole figure)
for which the cumulative total does not exceed the initial investment (in above
example, that would be year 2)
3. Compute the fraction of the following year’s cash inflow needed to “payback” the
initial cash investment as follows: take the initial investment minus the cumulative
total from step 2, and then divide this amount by the following year’s cash inflow
[For example, we have (100,000 - 73,962)/ 39,359 = 0.66]
4. To get the payback period in years, take the whole figure determined in step 2 and
add to it the fraction of year determined in step 3.
5. Thus our payback period is 2 plus 0.66 or 2.66 years.

Source: Fundamentals of Financial Management (11th Ed) by James C. Van Horne


and John M. Wachowicz. Jr.

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