The payback period is the length of time required to break even on an investment measured in years. Where the annual cash flow is identical, the payback period is equal to the investment divided by the annual cash flow. The payback period emphasizes the liquidity of an investment but not its value. Caledonia Products have both projects A and B at an equal negative value of ($100,000) in the first year at an 11% rate of return. Project
A YearUNDISCOUNTED FREE CASH FLOWSPVIF * 11%, nDISCOUNTED FREE CASH FLOWSCUMULATIVE DISCOUNTED FREE CASH FLOWS
1$32,000 .901$28,832.00 ($128,832.00)
2$32,000 .812$25,984.00 ($154,816.00)
3$32,000 .731$23,392.00 ($178,208.00)
4$32,000 .659$21,088.00 ($199,296.00)
5$32,000 .593$18,976.00 ($218,272.00)
3 years and 2 months
The payback period for project A occurs in three years and two months to recover the money.
BYearUNDISCOUNTED FREE CASH FLOWSPVIF * 11%, nDISCOUNTED FREE CASH FLOWSCUMULATIVE DISCOUNTED FREE CASH FLOWS
1$0 .901$0.00 ($100,000.00)
2$0 .812$0.00 ($100,000.00)
3$0 .731$0.00 ($100,000.00)
4$0 .659$0.00 ($100,000.00)
5$200,000 .593$118,600.00 ($218,600.00)
The payback period for project B occurs in four and half years to recover the money. Net Present Value at an 11% Rate of Return
Net Present Value (NPV) is the standard method for the financial appraiser of long-term projects. Measuring the excess or shortfalls of cash flows is to measure the difference of the invested and market cost. This method is a good investment, if of course, it brings money to the company, after the discounted rate is calculated. The discounted rate is the project’s Cost of Capital. If the present cash flows and future cash flows are done correctly, this will give the company the New Present Value. Thus, the projects should be accepted only if the plus is on the calculations of Net Present Value NPV > 0 measurements of time, profitability, value to the organization value to the shareholders.
Internal Rate of Return
The internal rate of return used for investments which produces cash flow over time. Internal rate of return is the discount rate that makes the net present value those cash flows equal to zero. The initial outlay for each project was $100,000. Project A’s internal rate of return is 18% while project B’s internal rate of return is 15%. Both projects have significantly higher internal rates of returns compared to the average. Project Ranking Conflict
The project ranking conflict has three different types of problems when reviewing and comparing two different project proposals, which are a disparity in size of the projects; a disparity in time or an unequal lives problem. If the problems do not rank the same, than the error is usually due to one of these problems and they have to be carefully reviewed and calculated to determine which project is the most efficient project for the company. The ranking problem...