Defining the Rule

We can illustrate how to calculate a payback with an example. Figure 9.2 shows the cash flows from a proposed investment. How many years do we have to wait until the accumulated cash flows from this investment equal or exceed the cost of the investment? As Figure 9.2 indicates, the initial investment is $50,000. After the first year, the firm has recovered $30,000, leaving $20,000. The cash flow in the second year is exactly $20,000, so this investment "pays for itself' in exactly two years. Put another way, the

Ross et al.: Fundamentals I IV. Capital Budgeting I 9. Net Present Value and I I © The McGraw-Hill of Corporate Finance, Sixth Other Investment Criteria Companies, 2002

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CHAPTER 9 Net Present Value and Other Investment Criteria 279

Net Project Cash Flows

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