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)