Essay About Payback Period And Payback Period Of A Project

Harding Case Stuy
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GROUP ASSIGNMENT – ANSWERS (AMIR FARID AZMAN)Question 1Time of Cash FlowNano Test TubesMicrosurgery KitCFAccumulated CFCFAccumulated CFInvestment $     (11,000.00) $                      (11,000.00) $   (11,000.00) $                      (11,000.00)Year 1 $         2,000.00  $                        (9,000.00) $        4,000.00  $                        (7,000.00)Year 2 $         3,000.00  $                        (6,000.00) $        4,000.00  $                        (3,000.00)Year 3 $         4,000.00  $                        (2,000.00) $        4,000.00  $                          1,000.00 Year 4 $         5,000.00  $                          3,000.00  $        4,000.00  $                          5,000.00 Year 5 $         7,000.00  $                        10,000.00  $        4,000.00  $                          9,000.00 [pic 1][pic 2]Payback period for:-Nano Test Tubes = Almost 3 years (2.75 years)Microsurgery Kit = More than 3 years (3.4 years)The rationale behind the payback method is to identify the period of time required to recover the funds expended in the investment. In this case, from the two proposals presented, by virtue of this method only, it seems that that Nano Test Tubes is more attractive.The decision rule for the payback method are as follow:If payback period < the minimum payback, ACCEPT the projectIf payback period > the minimum payback, REJECT the projectThe shorter the payback period of a project, the more attractive the project will be to management. In addition, management typically establishes a maximum payback period that a potential project must meet. The general rule to rank mutually exclusive projects is as follow:If payback period for project A < project B => Choose project AWhen two projects are compared, the project that meets the maximum payback period and has the shortest payback period is the project to be accepted. It is a simplistic measure, not taking into account the time value of money, but it is a good measure of a projects riskiness.The advantages of payback method:It’s quick and easy to applyServe as a rough screening device, identify attractiveness of a project from a surface point of viewProvides some information on the risk of the investmentProvides a crude measure of liquidityThe shortcomings of this method:Ignore the time value of moneyIgnore the cash flow after the payback periodIgnore profitability of the projectIgnores the risk of the future cash flowNo concrete decision criteria to indicate whether the investment increases the company’s valueQuestion 2Time of Cash FlowNano Test TubesMicrosurgery KitPresent ValueAccumulated DCFPresent ValueAccumulated DCFInvestment $         (11,000.00) $           (11,000.00) $         (11,000.00) $                      (11,000.00)Year 1 $              1,818.18  $             (9,181.82) $              3,636.36  $                        (7,363.64)Year 2 $              2,479.34  $             (6,702.48) $              3,305.79  $                        (4,057.85)Year 3 $              3,005.26  $             (3,697.22) $              3,005.26  $                        (1,052.59)Year 4 $              3,415.07  $                 (282.15) $              2,732.05  $                          1,679.46 Year 5 $              4,346.45  $                4,064.30  $              2,483.69  $                          4,163.15