Question

nNPV ROI and PAYBACK PERIOD?

Answer 1

NPV ( Net Present Value): NPV is the total of all future cash flows of an investment over a period of time. The future cash flows may be positive, negative, or zero. All the future cash flows are discounted to the present using a discount rate. The discount rate is the expected rate of return for the investment.

For an investment to be considered feasible, its NPV should be non-negative.

For example: If the future cash flows for years 0 to 2 are: - 40,000, 20,000 and 25,000 and the Discount rate is R%.

NPV = ( -40,000)/ ((1 + R)^0) + ( 20,000) / (( 1 + R)^1) + (25000) / (( 1 + R)^2)

ROI (Return on Investment): ROI is the ratio between the profit from an investment and the total cost of the investment.

A high ROI is always preferable.

In case of loss, the ROI is negative

For example: If an investment of $ 100,000 gives a profit of $ 5,000

ROI = 5000 / 100000 = 0.05 = 5%

Payback Period: Payback period is the amount of time required to recover the total costs of an investment. A low Payback period is always preferable.

For example: If an investment of $ 10,000 gives returns of $ 3000 in the first year, $ 3000 in the second year, and $ 4000 in the third year.

The total return in 3 years = 3000 + 3000 + 4000 = $ 10,000

So, the total time required to recover the investment cost of $ 10,000 = 3 years

Therefore, the payback period is 3 years.