Payback Period Analysis

Question 1: You dispute, that the PP method allows managers to determine whether or not a investment project is profitable or not. However Atrill and McLaney (2009, site 268) argue that the technique is not concerned with profitability, as it does only calculate the cash flows. Second, additionally you state that the primary reason to utilize it is based in its simpleness as well concerning make decision. I agree with the fact of straightforwardness however, believe the space of the payback period is the main element to the decision making process (Atrill and McLaney, 2009, page 267). Your comment?

Answer

Investment decisions often have to be pre-evaluated and a quick way of measuring viability is necessary before due awareness can be meted out. It's important to utilize simple measures to evaluate profitability measures on investments that would make decision making easier and clearer. The payback period is a solution that is both simple and effective: the thought of a payback period is important from a financial perspective.

The strategy evaluates a project on the amount of time that might be needed to earn again the investment worthy of today. Since it negates enough time value of profit its simpler form, it is an extremely basic and just a little overestimated projection of your break-even. This break-even has a financial bearing more important than the ease of the tool warrants for. It calculates enough time for which the benefits from a task will directly add towards the original capital invested. A manager may find a project which could have a good life of 5 years and a payback amount of three years. This practically means that the first three years, the project will not be making any new money. However, after the break-even is fulfilled, the task will add value to the business for two complete years. Another task with a payback period of 24 months but with a useful life of 2. 5 years may simply be turned down based on the payback period since the value added tenure is less.

This simplistic evaluation and ease of computation makes the payback a predominant choice for managers to pre-screen tasks and select practical ones - which are in terms of the time period companies are willing to keep their capital tied up (Atrill & McLaney, 2009).

Question 2: You said that payback method allows managers to learn job that are profitable and those that aren't. Would you not feel that by considering success the managers should take into cognisance the length of time of the job be it small amount of time or long time as this may also affect income?

Answer

The use of the payback period to evaluate investment decisions is not among the finest of practices. The payback amount of a task informs managers the time period during which they'll be recovering their initial investment. While financial investment analysis needs to be more in depth and adept, the tool pays to when the period of time for investment must be looked at more than the time value of future cash flows.

However, the value of the payback period can be known by the fact that investment earnings are gauged by the period of time that their dividends are of material value. The space of a task is in the end, a key determinant in evaluating a project's viability. Investment funds with an extended horizon may have an increased net present value but the returns may be more distributed beyond the life circuit of the job thus making the investment not that attractive in the short-term. On the other hand, a project with a shorter payback period may have less world wide web present value but risk turning out to be of more material importance credited to it having a higher short-term value. Thus, the space of any investment, as denoted by the payback period, is an integral evaluation criteria for managers to consider when valuing different investment projects.

Question 3: I tend to support this view in up to now that future project benefits beyond the task life cycle are often not well realized or simply at the mercy of significant uncertainty. These benefits are therefore often considered less important or even to difficult to quantify than the huge benefits that occur early on in the life span circuit, to your point. With this context the period of payback remains an important concern for professionals. Your thought?

Answer

The most important in financial management - the time value of money - is overlooked in the calculation of the payback period. However the low priced payback period uses the discounting notion, the emphasis of the payback period is to evaluate the time duration that investment creates some advantage of value. Historical tendencies claim that cash moves become progressively more uncertain once we move further into time.

Thus, predicting any dividends beyond the life cycle of any investment isn't only a futile process, but it generally does not represent a substantial contribution. Those benefits or results are rarely considered to be of material value and so negated when using the payback period. The assumption would be that the most valuable benefits will be realized through the life cycle of the project - thus it becomes a very important tool for managers to evaluate a project in conditions of its useful life. Benefits occurring early in the life span of the task are at the mercy of lesser discounting and therefore are warranted for in the calculation of the payback period so that it is an important awareness for managers (Atrill & McLaney, 2009).

Question 4: You made a good point that in case of two jobs or investment which has shorter or longer payback period, it will focus on the the one that will recuperate quickly, does this mean that brief payback period is preferable to long payback period in conditions of the benefit?

Answer

In conditions of benefits usually high risk projects involves high go back and low risk projects involves low come back but the circumstance can change based on kind of risk i. e. whether is risk is bound to project only or it's the risk which results the whole market; as market risks cannot be taken away completely and job risks can be eliminated.

Whenever there may be risk involved and when the professionals and especially the shareholders are of risk averse dynamics then it is advised to defend myself against projects with brief payback periods, as in short run environment is relatively predictable and will not tends to change a lot; therefore, shareholders can make certain of a return on their opportunities but if the professionals and shareholders are prepared to take dangers and there are less likelihood of the surroundings getting changed over time then the professionals can go with projects with long payback periods which often have high earnings attached with them (Atrill & McLaney, 2009).

Returns on the project or benefits received by the shareholders by making an investment on a job do be based upon payback period and when benefits are involved, projects with much longer payback period are better usually.

Question 5: What about considering the complementary dynamics of the tasks (PP)? Can you say that managers should consider the complementary aspect of projects when selecting them (PP Methods)? Will this help them in attaining the overall targets of the shareholders or they need to look at tasks in isolation?

Answer

The overall objectives of the shareholders is to maximize profits and lessen the chance mainly, there a wide range of numerous ways implemented by the shareholders to be able to accomplish their targets. If we discuss the payback period method then lessening the risk will be the jist of the research since payback period cannot calculate gains made by a job and it calculates enough time investor is likely to receive again the payments i. e. the chance involved with the project; if higher the time greater the chance.

It pays to consider assignments in isolation because every project has different payback durations and thus entails different varieties of risks with it especially if the task can suffice together but if the task cannot suffice only that is the product made from the project has no so this means without its supplement and there is absolutely no substitute of that complement then it is wise to consider complementary aspect of the tasks in particular when taking decisions of hauling on with the jobs.

Managers should check out complementary nature of the project when selecting them; it somehow reduces the chance and concern with nonexistent of complementary products in the market thereby minimizing the chance of the shareholders and gratifying their overall objectives.

Question 6: Very interesting post, the point you make about risk is interesting, however, Personally i think that if risk is to be assessed properly then managers must use the level of sensitivity examination (SA) (Atrill and Mclaney, 2009, Webpage 292). This is a far more encompassing method and really outways the little skills of PP to examine risk. Your comment?

Answer

Sensitivity analysis is a good tool in analyzing and examining risk; however, it is useful only when conditions tend to change. Sensitivity analysis is used when there exists some uncertainty in the foreseeable future and there are likelihood of conditions which were held constant while using payback period method are likely to change.

However, the payback period method is straightforward to make use of, to calculate also to understand. It offers approximate answer and it can involves some sort of judgmental and behind the back computation to forecast amount of returns expected which can require sensitivity research; but doing sensitivity analysis by managers is a big process, it requires lots of time and knowledge to comprehend the results. Without doubt payback period does not consider changes in the parameters of the model over time, which is improbable to be true, however the only gain payback has over level of sensitivity research is its simple computation and manipulations.

In the long term it depends from managers to managers whether they want the answers quick or they want detailed and exact answers while considering on adopting the nature to be a risk taker or a risk averse for the project (Atrill & McLaney, 2009).

Question 7: I trust your assertion "Therefore, used managers can combine the two ways of investment appraisal to leverage on their individual strengths to arrive at good investment decisions. "Only using one approach is limited when wanting to consider such decisions in a alternative manner especially when as you have mentioned in your post guaranteeing the creation of riches for share holders. The problem is there are many financial variables involved and all should be consider, no decision is simple and therefore we ought to not make it over a simplistic premise only. Your comment?

Answer

No doubt there are numerous financial factors available and are participating when taking investment decisions and payback period is one the most commonly used by professionals while considering about quick earnings and less risky tasks. However, payback period does not consider future revenue in its evaluation and it holds all parameters regular which in a true environment is extremely hard. Therefore, it is wise for managers to make use of multiple financial factors while taking an financial commitment (Curtis & Gobham, 2005).

No decision should be produced solely on the chance involved with the project, there can be projects that provides high return and involves high risks as well; thus it isn't necessary that each time low risk jobs are good only. Professionals must use financial factors and choose most suitable choice of financial parameter as per the nature of the company and character of shareholders. When the firm and shareholders want high return and are of risk taker character then managers must use inner rate of go back method in case company and the shareholders are of risk averse mother nature then the managers can go with payback period method. However, no method is the most practical method.

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