Calculate the Payback Period of Each Project
Essay by Emmjay5 • May 10, 2019 • Case Study • 1,739 Words (7 Pages) • 605 Views
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NAME : MONICA JANGARE
ID : 1207172005
COURSE NAME : CORPORATE FINANCE
COURSE CODE : FIN3433
TUTORIAL : 1
SUBMISSION DATE : 27th DECEMBER 2018
- 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 |
- 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 |
- 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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