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if the cash flows given are even for the first 4 years n the next year its different…for eg…initial investment 120k
cash flows ; 15k , 15k , 15k ,15k , 200k
and the realisable value is 20% of the initial cost….
in this case while calculating the payback period in the normal way….are we supposed to include the realisable value at the end of the period ie…200k+24k ….bcoz in d kaplan text in 1 question the have not considered the realisable value while calculating the payback period….why is it so ?…pls helpWhat I think of this is:
Normally we don’t take the initial investment’s value in payback’s calculation.. coz when we talk about normal payback approach one logical argument is that scrap value at the end of useful life can’t b assumed to spread evenly through out the year i.e its certain that it will be recovered at the end so to calculate the no of months in ur case it is wise to exclude the scrap proceed and take 200k only because it can b assumed to b spread evenly over the year 🙂 hope u got it
getting into further detail if u want to go into depth:
If the company is considering to bailout its investment even before the useful life then scrap value is also considered at the end of every year not just at the end of last year..! its called bailout payback period this approach is normaly suitable if the firm wants to avoid loss due to current financial position of the firm..Nokia is correct (except for the first line being a little confusing 🙂 )
We do not normally take into account the sale value of the investment because if it is decided to accept the investment then we would normally be intending to keep it for the duration.
The whole point of looking at the payback period is that other methods of appraisal (in particular NPV) are using the cash flows that are going to be just estimates. The further into the future we are estimating, the more uncertain the estimates will be. (The estimate of a flow in 10 years time, for example, will be little more than a guess!!). The earlier flows are still estimates but are likelier to be more realistic.
By calculating the payback, and having a target (e.g. 4 years) then at least we will be more confident that the investment will actually pay for itself!
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