Concept of payback period and capital budgeting







Concept of payback period and capital budgeting

->Payback period
 
* Payback represent the number of year required to recover the original cash out lay invested in a project .
*Basis of payback period is the calculation of recovery time
*The number of year required to recover the cost of the investment
* " Payback period in capital budgeting refers to period of time required to recoup the fund expended in an investment, or to reach the break even point " 
*Payback period usually expressed in years.
*It measures how long something takes to " pay for itself "
*Shorter payback period are more preferable than longer payback period.
*It is easy to apply and understand for most individual , regardless of academic training.

->  Construction

   *calculate net cash flow 

 I-  Net cash flow for 1st year = cash inflow of 1st year - cash outflow of 1st year

II- Cumulative cash flow =  Net cash flow for 1st year + Net cash flow for 2nd year + Net cash flow for 1st year as on

 *Accumulate by year until cumulative cash flow is a positive number that year is the payback year.
*Payback period does not take into consideration "the time value of money"  

 -> Capital budgeting

Capital budgeting , or investment appraisal is the planning process used to determine whether an firm's long term investment such as new machinery , replacement of machinery , new plant etc, are worth the funding of cash through the firm's capitalization structure.


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