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Payback (Analyse cumulative cash flows (Find out point when firm pays back…
Payback
Analyse cumulative cash flows
Year
Project A
Cashflow for project A
Project B
Cashflow for project B
Find out point when firm pays back
Divide Negative Cash flow by input
Payback Period Advantages
Simple Concept to understand
Easy to calculate (provided future cash flows have been calculated)
Uses cash, not accounting profit
Takes risk into account (in the sense that earlier cash flows are more certain)
Payback Period Disadvantages
Considers cash flows within the payback period only: says nothing about project as a whole
Ignores size and timing of cash flows
Ignores time value of money (although discounted payback can be used)
Does not really take risk into account.
Years to cover the initial investment
Can be discounted (discounted payback) or non discounted (simple payback)
A good initial investment appraisal tool - especially for risk averse firms