Page 109 - DBP5043

PROJECT VALUATION TECHNIQUES

Formula:

Number of years before year of recovery + CF for the recovery year
 CF in the recovery year

Payback Period advantages:

a) Computation of the technique is simple

b) Used as the first technical evaluation prior to use the techniques so as
guidelines for the selection of a project.

Payback Period Weaknesses:

a) Not taking into account cash flows after the payback period. This is
because a project may have a large cash flow after payback period

b) Not taking into account the present value of money

Example 1:

ABC Company is currently making an assessment on three potential
projects. Information for the three projects are as follows;

Initial investment Project X Project Y Project Z
(RM) 100,000 50,000 95,000

Year Annual cash flow after tax
1 40,000 15,000 35,000
2 35,400 25,000 35,000
3 33,600 20,400 35,000
4 30,500 18,000 25,000

You are required to calculate Payback Period for the three projects above.
State which project should be selected by ABC Company if the required
payback period is 3 years with the following conditions:
a) The removal of each
b) The independent