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Calculate the Payback Period of Each Project

Essay by   •  May 10, 2019  •  Case Study  •  1,739 Words (7 Pages)  •  31 Views

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NAME                    : MONICA JANGARE

ID                            :  1207172005

COURSE NAME  : CORPORATE FINANCE

COURSE CODE    : FIN3433

TUTORIAL            : 1

SUBMISSION DATE :  27th DECEMBER 2018

  1. The payback period is not appropriate in the analysis of the projects because it does not properly account for the time value of money, risk financing and other important considerations such as opportunity cost and it does not consider cost of the capital. It also doesn’t specify any require comparisons for taking or rejecting the project and the fact that it ignores the cash flows occurring after the payback period.

CALCULATE THE PAYBACK PERIOD OF EACH PROJECT

SYNTHETIC RESIN                                                                                        

CASH FLOW                          CUMULATIVE CASH FLOW

0

($100000)

($1000000

1

$350000

($650000)

2

$400000

($250000)

3

$500000

$250000

4

$650000

$900000

5

$700000

$16000000

payback

=

2

+

250000

500000

=

2.5 years

EXPOSY RESIN

CASH FLOW  

CUMULATIVE CASH FLOW

0

($800000)

($800000)

1

$600000

($200000)

2

$400000

$200000

3

$300000

$500000

4

$200000

$700000

5

$200000

$900000

Payback

=

1

+

200000

400000

=

1.5 years

  1. No Tim should not ask the Board to use DPP as the deciding factor as it simply ignores all cash flows after the payback period. Also DPP tends to provide very little useful information even though it accounts for time value of money. This can therefore lead to rejection of good wealth creating projects.

CALCULATE THE DISCOUNTED PAYBACK PERIOD

SYNTHETIC RESIN

CASH FLOW

 PV CASH FLOW

CUMULATIVE

0

($1000000)

($1000000)

($1000000)

1

$350000

$318185

($681815)

2

$400000

$330560

($351255)

3

$500000

$375650

$24395

4

$650000

5

$700000

payback

=

2

+

$35255

=

2.94years

$375650

EXPOXY RESIN

PV CASH FLOW

CUMULATIVE CASH FLOW

0

($800000)

($800000)

($800000)

1

$600000

$545460

($254540)

2

$400000

$350560

$76020

3

$300000

4

$200000

5

$200000

payback

=

$254540

=

1.77 years

$330560

  1. CALCULATE THE ARR

SYNTHETIC RESIN

YEAR

1

2

3

4

5

NI

150000

200000

300000

450000

500000

Initial investment

1000000

Salvage value

0

ARR

0.64

EXPOXY RESIN

YEAR

1

2

3

4

5

NI

440000

240000

140000

40000

40000

Initial investment

800000

Salvage value

0

ARR

0.45

 

The ARR for both projects is higher than 40% so it may be difficult for Tim to make a decision since both projects will generate wealth. They would choose the EXPOXY project because it has a percentage close to 40% but the problem is that ARR is based on profits rather than cash flows and it fails to account the timing of profits.

...

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