222

$show=home

Welcome to Accounting Education

The Accounting University with 3400+ Accounting contents as study material which can watch, read and learn anyone, anywhere.

Start your studies

$show=home

Journal Entries $type=three$count=6$author=hide$comment=hide$label=hide$date=hide$show=home$s=0

Balance Sheet $type=three$count=6$author=hide$comment=hide$label=hide$date=hide$show=home$s=0

Pay-back Period Method of Capital Budgeting - Simplest Technique of APC

Yesterday, I saw the paper of MBA and found the question “What is pay-back period method of appraising capital expenditure projects? What are its merits and demerits? This question is taken from the methods of capital budgeting one of chapter of Management Accounting . Pay-back period method is the traditional method of capital budgeting.

Meaning of Pay-back period

Pay-back period is the period in which investors obtains his amount of investment in fixed asset. Suppose, you have purchased the fixed asset of Rs. 100000 and after operating this fixed assets in business and earned Rs. 100000 in three years. Therefore 3 years are the pay-back period of investment in fixed asset. This period can also estimate on the basis of previous experience with same project.

Pay-back Period Method

After knowing what pay-back period is, it is easy to understand pay-back period method. It is the method in which we calculate pay-back period of different projects in which investor can invest his money. After this, investor compares length of period. Investor will accept only that project for the purpose of investment whose pay-back period is least out of different alternatives of projects. Other projects will be rejected.
If there is only one project in which investor wants to invest. At that juncture, investor will accept the project if its pay-back period will be less than standard pay-back period which is made by the management of investor or company.
Steps to Calculate Pay-back period

Ist Step

Calculate Net profit before depreciation and after tax. It is annual cash flows.

2nd Step

Calculate Pay-back period

(A) When annual profits on investment before depreciation and after tax are equal



(B) If Annual cash inflow is not equal, then add these till it equal to cost of project. After this, count this period.

Example


A project costs Rs. 100000 and yields annual cash inflow of Rs. 20000 for eight years. Calculate its pay back period.
In this case we will choose (A) from second step because annual profit on the project is equal




Practical Use of this method in appraising capital expenditure projects
Suppose, an investor has looked a machine in two company which can do same work. Its cost is also same of Rs. 20000. Now investor has to decide which machine, he has to purchase on the basis of given A machine and B machine.


The following information is given by machine providers. Net profit before depreciation and after tax from machines




Pay-back period of machine A is 5 years


Because if we add the profit from machine a , it will be equal to Rs. 20000 which is cost of machine


First year profit 1000 + second year profit 2000 + third years profit 4000 + fourth year profit 5000 + fifth year profit 8000 = Rs. 20000


In machine B, the payback period is 4 year because cost of machine can obtain from its profit with in 4 years [* for calculating payback period part (B) of Step 2 will apply]
Hence, investor should purchase B machine because according to pay-back period, it will return the expenditure of machine purchasing before Machine A.
Special Tips for Calculating Pay-back period ·

If in practical question , rate of depreciation and tax are given , then annual profit will be adjusted from them

Annual profit or annual cash flow

= Annual net profit + Depreciation – Tax

· If adding the total of annual profits are not equal to cost of project , then following formula can be used


Merits of Pay- back Period Method

1. This method is easy to understand.
2. A small investor can calculate this period himself and save money which he has to give to financial analyst.
3. In this method, investor can save from obsolescence . Obsolescence is loss due to changing in technology. Because, Investor will prefer that fixed asset which return his investment cost within shortest time.

Demerits of Pay-back Period Method

1. In the beginning of any fixed asset, it may possible that fixed asset will not give higher profit but after some times, it will start higher profit. So, this method is not proper evaluation of profitability from different assets.

2. This method ignores the time value of money. It means the value of One rupees which we have earned today is more than which we will earn after one year. Suppose two projects have same payback period which is 5 year but first project is giving profit by increasing its amount Rs. 1000 , 2000 , 3000 , 4000 , 5000 and other project is giving profit by decreasing its amount Rs. 5000 , 4000 , 3000 , 2000 , 1000 . According to payback period, both project are good but in reality B project is better than A because, it is giving higher profit in first and second year.

3. Cost of capital is also ignoring in this method. Suppose, if we purchased asset on loan, then we also check what is rate of loan and compare it with profitability of asset.

Comments

: 1
In comment, you can give your feedback, reviews, ideas for improving content or ask question relating to written content.

 


Name

access,2,account,86,accountant,95,Accounting,683,accounting definitions,99,accounting ebook,3,Accounting education,85,Accounting Education Ads Help,1,accounting procedure,2,accounting process outsourcing,2,Accounting Software,52,advance,3,advertising,6,africa,7,Amalgamation,6,amendments,16,Amortization,1,announcements,62,Annuity,2,assets,53,audit,47,auditing,41,Australia,2,B.Com.,22,balance sheet,87,bank,111,Bank reconciliation,12,banking,33,basic accounting,110,BBA,1,benefits,13,best,50,bill,12,black money,3,blog,12,bloggers,7,book keeping,4,bookkeeping,3,Branch Accounting - full tutorial,8,budget,35,Budget variance,13,business,65,businessman,9,CA,30,calculator,4,canada,3,capital,72,capital budgeting,27,career,21,cash,40,cash book,8,cash flow statement,11,Chiense,1,children,13,china,6,class,3,coaching,2,coins,2,college,6,commerce,10,commerce students,7,company,36,computer,9,computer accounting,1,conference,4,Contact vinod kumar,1,Control Your Spending,27,corporate accounting,69,cost,160,cost accounting,195,cost center,8,cost centre,1,CPA,2,credit,18,credit card,11,cs,10,currency,35,data,11,Debit and credit,17,debit cards,1,debt,62,debtor,21,degree,6,depletion,2,depreciation,38,Diwali Messages,12,documents,4,dollar,5,domain,3,Downloads,3,Dubai,1,e-accounting,17,earning,17,education,246,Education Loans,6,email,15,employee,4,EPF,2,ERP,7,euromoney,1,examination,7,excel,17,excise duty,6,expenses,65,facebook,7,factor of loan,1,fans,2,feature,32,fifo,5,FII,4,fiji,1,finacle,1,finance,823,Finance Journal Entries,6,Financial,134,financial accounting,147,Financial Statements,4,fire insurance,3,flickr,2,flow,4,forensic,4,forex,21,formula,8,france,1,fraud,6,free,2,fun,34,function,1,fund,48,GAAP,36,GDP,1,gdr,5,germany,1,gold,7,goodwill,4,goodwill accounting,3,google,34,google apps,3,google apps,1,google base,1,google buzz,1,google calendar,1,Google docs,38,google finance,3,google fusion tables,1,google talk,5,govt.,5,GST,33,guide,85,health,6,Hindi,2,Hindi Language,3,history,3,holding company,3,How to treat FBT in Tally 9,1,HRA,3,ICAI,11,ICAWI,3,ICICI Bank,1,IFRS,11,income,17,income statement,19,Income Tax,7,India,57,indian railway,1,Indonesia,1,inflation,4,inflation accounting,3,infographics,8,information,7,inspiration,176,insurance,14,insurance accounting,2,Intangible,3,interest,26,international,7,Internet,40,Introduction of Tally 9,1,inventory,41,investment,135,investment in Shares,6,invoice,3,IT,1,Japan,1,Job costing,4,journal entries,143,Journal Entries eBook Help,4,Kalculate,1,keyboard,3,kuwait,2,laptop,2,law,4,LBT,1,learning,36,lease,5,lecture,11,ledger,17,leducation,1,Leverage Analysis,7,liabilities,16,lifo,3,linkedin,1,loan,74,logical point,1,loss,5,loss of profit,1,M.Com.,5,m.phil,2,malaysia,3,management accounting,129,manual accounting,4,manufacturing account,1,market,11,marketing,3,mastercard,2,material,13,MBA,14,MCA,1,media,4,migration,2,mobile,9,money,61,ms word,3,ms. excel,14,multi currency in tally 9,1,Multicurrency Accounting,3,mutual fund,30,national security,1,new and sacrifice ratio,1,new york times,1,new zealand,1,news,1,NGO,5,nonprofit-accounting,6,North Georgia Mountains,1,Notification,1,NPV,17,NSE,1,odbc,2,office,10,oman,1,online application,2,online accounting,11,Online Accounting Course,5,otcei,1,pakistan,3,parents,3,Partnership,1,pay pal,3,pdf,4,Personal Finance,6,pie chart,1,pie chart of income,2,pnb,5,podcast,1,ppf,1,presentation,10,price,7,privacy policy,2,prof. vinod kumar,13,profit,24,profit and loss account,12,project management,11,provision,14,purchase,9,puzzles,2,quickbooks,2,Quote,22,quotes,42,quotes of svtuition,1,rating agency,2,ratio analysis,34,RBI,7,readers,13,real estate,13,rectification of errors,11,remote control,2,reports,10,reserves,8,responsibility accounting,4,retirement,2,revenue,3,Revenue reserves,2,review,7,risk,11,rupees,9,salary,5,sale,12,SAP,3,saudi arabia,1,saving,19,sbi,9,scholarship,2,school,1,SEBI,13,security,30,service tax,23,share,20,share trading,15,Shares,16,shri lanka,3,singapore,2,sms,6,social accounting,7,society,5,solution,219,South Africa,1,stock,24,stock exchange,22,structure,6,student,39,students,70,study,21,subsidiary company,2,svtuition,14,swiss bank,2,tally,100,tally 9,8,Tally 7.2,8,Tally 9,42,Tally.ERP 9,59,TallyPrime,1,tanzania,2,tax,94,Tax Accounting,30,TDS,15,teacher,62,teaching,112,technology,33,test,40,testimonial,15,testimonials,15,thailand,1,tips,60,trading,5,trading on equity,2,transaction,7,trend,12,trial balance,14,truthfulness,1,tuition,3,twitter,10,UAE,5,UGC - NET Commerce,13,UK,11,United Arab Emirates,1,university,9,usa,25,valuation,9,VAT,22,Video,36,Voucher and vouching,4,Wealth,8,wikipedia,25,working capital,29,youtube,14,
ltr
item
Accounting Education: Pay-back Period Method of Capital Budgeting - Simplest Technique of APC
Pay-back Period Method of Capital Budgeting - Simplest Technique of APC
http://3.bp.blogspot.com/_DJEIRrK4tl4/Sy9RqFzODnI/AAAAAAAAEhc/5r0u-B44tPo/s320/handwriting.PNG
http://3.bp.blogspot.com/_DJEIRrK4tl4/Sy9RqFzODnI/AAAAAAAAEhc/5r0u-B44tPo/s72-c/handwriting.PNG
Accounting Education
https://www.svtuition.org/2009/12/pay-back-period-method-of-capital.html
https://www.svtuition.org/
https://www.svtuition.org/
https://www.svtuition.org/2009/12/pay-back-period-method-of-capital.html
true
2410664366776677676
UTF-8
Loaded All Posts Not found any posts VIEW ALL Reply Cancel reply Delete By Home PAGES Contents View All RELATED CONTENTS FOR YOUR LEARNING Topic ARCHIVE SEARCH ALL POSTS Not found any post match with your request Back Home Sunday Monday Tuesday Wednesday Thursday Friday Saturday Sun Mon Tue Wed Thu Fri Sat January February March April May June July August September October November December Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec just now 1 minute ago $$1$$ minutes ago 1 hour ago $$1$$ hours ago Yesterday $$1$$ days ago $$1$$ weeks ago more than 5 weeks ago Followers Follow THIS PREMIUM CONTENT IS LOCKED STEP 1: Share to a social network STEP 2: Click the link on your social network Copy All Code Select All Code All codes were copied to your clipboard Can not copy the codes / texts, please press [CTRL]+[C] (or CMD+C with Mac) to copy