STD: T.Y.B.M.S. SEMESTER V
SUBJECT:
Financial Management TOPIC:
PBP, ARR & DPBP
SUBMITTED TO:
Prof. H. Shah
Of Commerce &
Management Studies
Name Roll no
JULFIKAR ALI 13 AJAY YADAV 14 ALI WARASI 15 NAVED KHAN 16
VASI-UZ-ZAMA 17 ARUN JAMES 18
PRESENTED BY:- GROUP 3
1.• Payback Period (PBP)
2.• Average Rate of Return (ARR)
3.• Discounted Pay Back
Period (DPBP)
Topic
It is one of derivative of cash flows.
It is a simple technique and does not
employ the discounted cash flows
techniques.
It measures the time within which the initial
investment of the project can be recovered
based on the cash accruals generated by
the project.
Payback Period (PBP)Meaning :-
Formula for calculating Payback period
1. PBP=
2. PBP= x 12 Months ) N= No. of years before final recovery C= Cash flow during the year B= Balance amount still to be
recovered
N +BC
(
1. Simple method and short calculation.
2. Method can be employed by layman.
3. Indicate the period within which the initial
investment would be recovered. Lower the
payback period more attractive would be
the project.
Advantages of Pay Back Period
1) It fails to consider the time value of money.
2) It ignored cash flow beyond the payback period.
This is lead to discrimination against projects,
which generate substantial cash flows in the later
years.
3) It may divert attention from profitability.
4) It does not indicate the liquidity position of the
firm as whole, which is more important.
Limitations of Pay Back Period
Example :-
Open Restaura
nt
Business!
Open Restaura
nt
Both writes their own Business Plan!
Mr. Kaliya Mr. Bheem
40,00050,00060,00050,000
40,00060,00060,00040,000
Cash Inflow Cash Inflow
Initial Investment = 170,000
Propose Business Plan
But
Only 1 will get selected
Whose business plan will get accepted?
Solution= PBP Method!
Mr. Kaliya’s
PBP for 3years= 150,0004th year’s cash inflow C= 50,000B= 20,000 (170,000- 150,000)
PBP=
=3years, 4.8 months
Mr. Bheem’s
PBP for 3years= 160,0004th year’s cash inflow C= 40,000B= 10,000 (170,000- 160,000)
=3years, 3 months
PBP=
Lastly Bheem hit Kaliya and open the
Restaurant!
=3years, 4.8 months
3years, 3 months =
Bheem’s Business Plan
gets accepted!
It attempts to measure the rate of return on investment.
Project expected to give return below this rate are rejected, otherwise accepted.
In case of several alternative investment proposals, project with higher ARR would be preferred to those having lower ARR i.e.
1. The original cost of investment2. Average investment
Average Rate of Return (ARR)Meaning :-
Initial cost of asset :Rs. 1,00,000 Estimated life : 4 years Scrap value(at the end of 4 years) :Rs. 20,000 Depreciation : Straight Line Method
Illustration
Average investment = 1,00,000 – 20,0002 + 20,000
= Rs. 60,000
Evaluation
1) It is easy to understand and simple to calculate.
2) It does not discount the future cash inflows.
3) This method does not differentiate the
alternative investment proposals in terms of
their magnitude of investments.
In this method the net present values are added
cumulatively from the start of the project until the
sum become positive.
DPBP is defined as the time as the invested capital
has been returned together with the interest cost of
associated fund.
Here the rate of discount used to arrive at the present
value of the net cash flows is the cost of capital.
Discounted Pay Back Period (DPBP)Meaning :-
Discounted Pay Back Period (DPBP)
Advantages:-1. This method takes into consideration the time value of
money by combining PBP with discounted cash flows.2. It consider requirement to make some return on
investment.3. It helps in the judgment of project risks.
Limitations:- This method is not useful for assessing profitability of the
whole project.
Illustration
Year
New cash flows (Rs)
PV Factor at 10%
PV of Net Cash flows (Rs.)
Communicative NPV (Rs.)
0 (10,000) 1.000 (10,000) (10,000)
1 4,000 0.909 3,636 (6,364)
2 3,000 0.826 2,478 (3,886)
3 4,000 0.751 3,004 (882)
4 2,000 0.683 1,366 484
5 4,000 0.621 2,484 2,968
Cost of project : Rs. 10,000Life :5 yearsCost of Capital :10%
The DPBP lies between 3rd & 4th years. By interpolation the pay back period is
3 +( 882 1,366)= 3.65 years
Financial Management (By ARVIND DHOND)