Cash Flow Based Decision Rules Payback

The payback on a project is a measure of how quickly the cash flows generated by the project cover the initial investment. Consider a project that has the following cash flows:

The payback on this project is between 2 and 3 years and can be approximated, based upon the cash flows to be 2.6 years.10

As with the other measures, the payback can be estimated either for all investors in the project or just for the equity investors. To estimate the payback for the entire firm, the free cash flows to the firm are cumulated until they cover the total initial investment. To estimate payback just for the equity investors, the free cash flows to equity are cumulated until they cover the initial equity investment in the project.

Illustration 5.10: Estimating Payback for the Bookscape Online Service

The following example estimates the payback from the viewpoint of the firm, using the Bookscape On-line Service cash flows estimated in illustration 5.4. Table 5.12 summarizes the annual cashflows and the cumulated value of the cashflows.

Table 5.12: Payback for Bookscape Online

Payback: The payback for a project is the length of time it will take for nominal cash flows from the project to cover the initial investment.

Table 5.12: Payback for Bookscape Online

Year

Cashflow in year

Cumulated Cashflow

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