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PAY BACK PERIOD - PBP
03-26-2011, 09:14 PM
Post: #1
PAY BACK PERIOD - PBP
Salaam Awl!
I have a query regarding PBP, PLs inform me through ur best knowledge and experience that wat is the role of cost of capital in PBP?? a question is as under for your information

Company A invest in project, initial investment required Rs. 75,000 for 5 years cash inflows are (15,000 12,000 8000 34,000 55,000). cost of capital is 5% p.a.

IN MY UNDERSTANDING

PBP= (Cash flow required) divided by (cash flow for the year)x 12

so according to me, the investment shall recover in 4 years & 1 month.
But em still not understand that why the COST OF CAPITAL is given in this question, Pleases explain as soon as possible.

Regards

Umar
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03-29-2011, 06:45 PM
Post: #2
 
Ok firstly u need to understand that there are 2 types of PBP

1. Simple
2. Discounted

In discounted PBP we calculate the PV of each cash flow and than use these figures to calculate PBP.

YEAR 1 15000 when discounted at 5% for 1 year is 14285.7
YEAR 2 12000 when discounted at 5% for 2 years is 10884.35
YEAR 3 8000 when discounted at 5% for 3 years is 6910.7
YEAR 4 34000 when discounted at 5% for 4 years is 27971.8
YEAR 5 55000 when discounted at 5% for 5 years is 43093.9

Now when we calculate PBP than 75000 - 14285.7 - 10884.35 - 6910.7 - 27971.8 = 14947.45

14947.45/43093.9 * 12 = 4.16

in other words intial investment will be recovered in 4 years and 4 months under discounted PBP
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