Page 412 - Corporate Finance PDF Final new link
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412 Corporate Finance BRILLIANT’S
Demerits Xmof
1. It does not take into account the returns 1. `h no-~¡H$ nr[a`S> Ho$ ~mX H$s Ad{Y _| àmßV hmoZo
from a project after its pay-back period. dmbo [aQ>Ýg© na Ü`mZ Zht XoVrŸ& CXmhaU Ho$ {bE,
For example, project 'A' may have a pay- `{X àmoOoŠQ> "A' H$m no-~¡H$ nr[a`S> 5 df© h¡ O~{H$
back period of 5 years whereas project 'B'
may have pay-back period of 3 years. Ac- àmoOoŠQ> "B' H$m no-~¡H$ nr[a`S> 3 df© h¡ Vmo Bg
cording to this method, project 'B' will be nÕ{V Ho$ AZwgma àmoOoŠQ> "B' H$mo ñdrH¥$V {H$`m OmEJmŸ&
selected. However, it is quite possible that {H$ÝVw hmo gH$Vm h¡ {H$ àmoOoŠQ> ‘A’ 5 dfm] Ho$ níMmV²
after 5 years, 'A' gives return of 20% for AJbo 4 dfm] VH$ 20% H$m [aQ>Z© XoVm h¡ O~{H$ "B'
another 4 years or so, whereas 'B' stops
giving return after 3 years. Therefore, the 3 df© Ho$ níMmV² [aQ>Z© XoZm ~§X H$a XoVm h¡Ÿ& h¡Ÿ& AV…
pay-back period may not be a good mea- no-~¡H$ nr[a`S>, Xmo Eogo àmoOoŠQ²>g H$m VwcZmË_H$
sure to evaluate where the comparison is _yë`m§H$Z H$aZo Ho$ {cE ~ohVa VarH$m Zht hmo gH$Vm h¡
between two projects, one with long-term
Ohm§ EH$ àmoOoŠQ> c§~o g_` Ho$ ~mX cm°ÝJ-Q>_© [aQ>Z©
return but with a long gestation period
and the other yielding quick results but XoVm hmo VWm Xygam Ho$dc Aën Ad{Y Ho$ {cE OëXr
only for a short period. [aQ>Z© XoVm hmo&
2. This method becomes a very inadequate 2. `{X {H$Ýht Xmo àmoOoŠQ> _| H¡$e BZâcmoO Ag_mZ h¢
measure of evaluating two projects where Vmo Bg _oWS> go ghr {ZîH$f© {ZH$mbZm H${R>Z hmoVm
the cash inflows are uneven. Consider the
following example, of cash flows from two h¡Ÿ& CXmhaU Ho$ {bE, {H$Ýht Xmo àmoOoŠQ²>g go {_bZo
projects: dmbo H¡$e âcmoO {ZåZ{b{IV h¢:
(Amount in `)
No. of years A B
1 Nil 40,000
2 Nil 50,000
3 5,000 1,20,000
4 20,000 10,000
5 50,000 10,000
6 1,50,000 Nil
7 50,000 Nil
8 40,000 Nil
Total 3,15,000 2,30,000
If both projects cost of ` 1,50,000, B has a `{X XmoZm| àmoOoŠQ²>g H$s H$m°ñQ> ` 1,50,000 h¡ Vmo
pay-back period of 2.5 years whereas 'A' no-~¡H$ nr[a`S> Ho$ AmYma na àmoOoŠQ> 'B' H$mo
has a pay-back period of 5.5 years, but 'A' àmW{_H$Vm {_boJr Š`m|{H$ CgH$m no-~¡H$ nr[a`S>
has a much higher return than 'B' and 2.5 df© h¡ O~{H$ àmoOoŠQ> 'A' H$m 5.5 df© h¡ {H$ÝVw
therefore, it should be preferred. Hw$b bm^ H$s Ñ{ï> go XoIm OmE Vmo àmoOoŠQ> 'A'
àmoOoŠQ> 'B' go A{YH$ bm^Xm`H$ h¡Ÿ& AV: Bgo
àmW{_H$Vm XoZr Mm{hEŸ&
