Calculation of payback and Discounted Payback Period PDF

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Calculation of payback and Discounted Payback Period Payback Period (PBP) and Discounted Payback Period (DPBP) have been discussed in detail in lecture # 10-11 along with examples. You are advised to watch the video lecture and consult the recommended book(s) for more practice questions. However, for your ease, concept of DPBP has been summarized in comparison with simple PBP: For example:

Years 0 1 2 3

Cash Flow -5,000 3,000 2,500 2,000

Cum. CF. 3,000 5,500 7,500

The simple payback period will be between 1st and 2nd year. Simple payback period = Years before recovery + (Amount to be recovered/ cash flow of recovery period)

Till first year, the recovered amount will be Rs. 3,000 and the unrecovered amount, which needs to be recovered in 2nd year is 5,000-3,000 = Rs. 2,000. Put the values in the above mentioned formula: Simple payback period = 1 + (2000 / 2500) = 1.8 years Discounted payback period is same as of the simple payback period with only difference that we first discount the given cash flows by using appropriate discount factor and then calculate the discounted payback period by using the following formula: Discounted payback period = Years before recovery + (Amount to be recovered/ discounted cash flow of recovery period)

If interest rate is 10% then the discounted cash flows are:

Years 0

Cash Flow -5,000

Discounted CF.

Cum. Disc. CF.

1 2 3

3,000 2,500 2,000

3000/1.10 = 2,727 2500/(1.10)^2 = 2,066 2000/(1.10)^3 = 1,503

2,727.00 4,793.00 6,296

The discounted payback period will be between 2nd and 3rd year. Till second year, the recovered amount will be 2,727+2066 = Rs. 4,793 and the unrecovered amount, which needs to be recovered in 3rd year is 5,000-4,793 = Rs. 207. Put the values in the above mentioned formula: Discounted payback period = 2 + (207/1,503) = 2.14 years Here you can see the difference that we first discounted the cash flows and then calculated the payback period while in simple payback period, we don’t discount the given cash flows....