A Note On The Financial Evaluation Of Projects
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NET PRESENT VALUE Contd..
|
|
Project X |
Project Y |
|
Initial Investment
|
Rs 35000
|
Rs 35000 |
|
CFAT
|
Rs 8750
|
Rs 11200 |
|
Payback period
|
4 yrs
|
3.12yrs |
When cash inflows after tax are constantly changing from
year to year, the method for calculating PB period is calculated in the
following manner:
|
Project X |
Project Y |
|
Year
|
CFAT
|
Cumulated CFAT
|
CFAT
|
Cumulated CFAT |
|
0
|
-155,000
|
-
|
-48000
|
- |
|
1
|
38000
|
38000
|
13500
|
13500 |
|
2
|
44000
|
82000
|
14700
|
28200 |
|
3
|
49000
|
131000
|
17300
|
45500 |
|
4
|
54500
|
185500
|
18800
|
64300 |
|
5
|
60000
|
245500
|
20500
|
84800 |
|
Payback period
|
3.129 yrs
|
|
3.038 yrs
|
Project X will recover Rs 131,000 of its initial investment in the
first three years. In the fourth year, it will recover the balance, i.e.,
(155000 – 131000 = 24000). The payback period in the fourth year is computed
as follows 24000/185500 = 0.129. Therefore, the investment in project X can
be recovered in 3.129 years. Similarly, the initial investment in project Y
can be recovered in 3.038 years.
The major advantages of this criterion are:
•Like ARR it is easy to calculate PB.
•It takes into account cash flows (and is hence superior to ARR).
•It helps identify projects which can earn quick returns (useful in
industries where rapid technological change is common).
This criterion has the following drawbacks:
•It does not consider the cash flows after the payback period.
•It does not consider the timing of cash flows.
•It does not show whether or not the project that has been accepted is going
to maximize the wealth of the stakeholders.
The evaluation criteria for this method are:
•The project is accepted when the actual payback period is less than the
required or predetermined payback period.
•The project is rejected when the actual payback period is greater than the
required or predetermined payback period.
•When there are mutually exclusive projects, the one with the lowest payback
period but less than cut off payback period must be selected.
More...
APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS
CONCLUSION
EXHIBIT I ASPECTS OF PROJECT APPRAISAL
EXHIBIT II PROJECT EVALUATION TECHNIQUES
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