Question

consider the following three projects. All three have an initial investment of $300,000

Net Cash Inflows
	Project L		Project M		Project N
Year	Annual	Accumulated	Annual	Accumulated	Annual	Accumulated
1	$75,000	$75,000	$25,000	$25,000	$150,000	$150,000
2	75,000	150,000	75,000	100,000	150,000	300,000
3	75,000	225,000	200,000	300,000
4	75,000	300,000	250,000	550,000
5	75,000	375,000	350,000	900,000
6	75,000	450,000
7	75,000	525,000
8	75,000	600,000

Required

1.

Determine the payback period of each project. Rank the projects from most desirable to least desirable based on payback.

2.

Are there other factors that should be considered in addition to the payback? period?

Answer 1

Answer 1

Note : Payback period the total time in which the cost of investment is expected to get recovered. Thus in the given question, the years at which accumulated net cash flow equals the initial investment of $300,000 is the payback period for the project From the above mentioned table we get the Payback period as - 4 years for Project L ,3 years for Project M , 2 years for Project N.

The most desirable project is one which have minimum Payback period & least desirable project is one which have maximum Payback period.

Table showing ranking for the projects from most desirable to least desirable based on payback

Projects	Payback period	Rank
Project N	2 years	1
Project M	3 years	2
Project L	4 years	3

Answer 2

Factors that should be considered in addition to the payback? period

• Net cash flow after payback period : The main objective of any business is not to just to recover the intial capital but also to earning profits. Thus cashflows after payback period should be consider for evaluting the profitability of different projects
• Time value of money : The concept of time value of money is one of the most important factor in determining the profitability of any project which is not considered in payback period method. Thus it should be considered in addition to the payback? period for better decision making.
• Use of different methods : Due to some drawbacks in payback period method , we should use other capital budgeting methods like NPV method , IRR method , Profitability index method etc for better decision making.
• Other factors : Other qualitative factors like social -economic factors , environment factors should be consider while evaluating any project. Such  qualitative factors directly or indirectly do impact the overall profitability.