Topic №11: Evaluation of financial and economic efficiency of investment projects

Example 2: Uneven Cash Flows Company C is planning to undertake another project requiring initial investment of $50 million and is expected to generate $10 million in Year 1, $13 million in Year 2, $16 million in year 3, $19 million in Year 4 and $22 million in Year 5. Calculate the payback value of the project.

• Example 2: Uneven Cash Flows Company C is planning to undertake another project requiring initial investment of $50 million and is expected to generate $10 million in Year 1, $13 million in Year 2, $16 million in year 3, $19 million in Year 4 and $22 million in Year 5. Calculate the payback value of the project.
• Solution;
• Payback Period = 3 + (|-$11M| ÷ $19M) = 3 + ($11M ÷ $19M) ≈ 3 + 0.58 ≈ 3.58 years or 0.58*365= 212 days PP=3 years, 212 days

(cash flows in millions)		Cumulative Cash Flow
Year	Cash Flow
0	(50)	(50)
1	10	(40)
2	13	(27)
3	16	(11)
4	19	8
5	22	30

But Payback has some serious disadvantages:

• - It does not take into account, the cash flows that occur after the payback period; - It takes no account of any income from reselling the capital asset later on; - It takes no account of the effect of time on the value of money.
• Payback is, however, a useful screening method for projects. A project with a Payback of a few months clearly deserves further investigation, whereas a project with a Payback of 10 years would usually have little chance to receiving funding.