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ENGR 3360U Winter 2014 Unit 5.5: Payback Period Analysis

This document is from an engineering economics course and discusses payback period analysis, which estimates the time required to recover an initial investment in a project. It describes two forms of payback period analysis: with no interest and with an assumed interest rate. The document cautions that payback period should not be used as the primary means of deciding whether to accept or reject a project, but is best as a preliminary screening tool. It provides the basic formula for calculating payback period and notes limitations of the method, such as ignoring cash flows after payback and not considering required rates of return.

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67 views6 pages

ENGR 3360U Winter 2014 Unit 5.5: Payback Period Analysis

This document is from an engineering economics course and discusses payback period analysis, which estimates the time required to recover an initial investment in a project. It describes two forms of payback period analysis: with no interest and with an assumed interest rate. The document cautions that payback period should not be used as the primary means of deciding whether to accept or reject a project, but is best as a preliminary screening tool. It provides the basic formula for calculating payback period and notes limitations of the method, such as ignoring cash flows after payback and not considering required rates of return.

Uploaded by

sunnyopg
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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ENGR 3360U Winter 2014

Unit 5.5
Payback Period Analysis
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 5 Present Worth Analysis

Change Record
2014-I-01 Initial Creation
Text Chapter 5

5-2

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

5.5 Payback Period Analysis


Also call payout analysis
Extension of present worth method
Two forms:
1.
2.

With no interest -- i = 0% (no-return payback)


With an assumed interest rate -- i > 0% (discounted
payback analysis)

Technique: estimates the time np to recover the


initial investment in a project, either with or
without interest earned

5-3

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Payback Period Analysis-RULE


Never use payback analysis as the
primary means of making an
accept/reject decision on an alternative!
Best used as a screening technique or preliminary analysis tool
Historically, this method was a primary analysis tool and often
resulted in incorrect selections
To apply, the cash flows must have at least one (+) cash flow in
the sequence

5-4

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Basic Formula for Payback Analysis


Determine the number of
years np that it takes for all
negative net cash flows to
exactly equal all positive
cash flows

t n p

0 P NCFt ( P / F , i %, t ).
t 1

If i = 0% and all NCF


estimates are the same, the
payback calculation
np = P/NCF
simplifies to

5-5

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Payback - Interpretations and Fallacies


Common managerial philosophy is that a shorter payback is preferred to a longer
payback period; this is not a good approach from economic vantage
Not a preferred method for final decision making better as a screening tool
Ignores all cash flows after the payback time period
May not use all of the cash flows in the cash flow sequence.

Dont use no-return (i = 0%) payback for final


decisions. It

Neglects any required return on the investment

Neglects all cash flows after time np including any positive cash
flows that contribute to making a positive return on the investment

5-6

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

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