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(8.1)
or,
cash flows in time t -investment cost>0
Disadvantages:
1. The time value of money is not considered.
2. The effect of cash flows (savings) after the payback period is not
considered
Advantage
1. A rapid pay back may be prime criterion for judging an investment when
financial resources are available to the investor only for a short period of
time.
2. The speculative investor desires for rapid recovery of the initial
investment.
3. The determination of breakeven life ( N * ) is helpful in accessing the
availability of achieving a successful investment.
190
S =CDB
(8.3)
A
A
=
S CD B
(8.4)
Example 8.1:
A company is considering installation of a new energy efficient equipment in its
manufacturing process. The installation cost of the equipment is estimated to be
Rs 20.0 Lakhs and equipment required Rs 60,000/year for annual operating cost.
The equipment is expected to save an average Rs 31,000 million kilo Joule per
year over next 10 years. Fuel cost is Rs 30/ million kJ. Calculate the pay back
period.
The management of the company has taken a decision to implement the scheme
so that there will be at least 50% ROI. Should the project be implemented or not.
Solution:
Capital= A = Rs 20, 00, 000.00
Running cost= B = Rs 60, 000.00
Annual fuel saving= C = Rs 31,500 106 kJ/kg
191
A
= 2.26 years
S
S
= 44.25%
A
A
= 200000
N
ROI =
S f
= 34.25%
A'
A' = A G
f =
A'
per year
N
192
(8.5)
(8.6)
G = A (1 f )
or,
log (1 f ) =
1
G
log
N
A
(8.7)
(8.8)
(8.9)
or,
1 f = exp
1
G
log
N
A
(8.10)
1
G
log
N
A
(8.11)
or,
f = 1 exp
1. At the end of 1st year, Rs. P is deposited to bank. After ( N 1) years this will
be worth P (1 + i )
N 1
2. At the end of 2nd year, Rs P is deposited to bank, after ( N 2 ) years, this will
be worth P (1 + i )
N 2
N 1
+ P (1 + i )
N 2
+ P (1 + i )
N 3
+ ........ + P (1 + i ) + P
or,
P (1 + i ) 1
(8.13)
S=
(8.12)
=A
'
Example 8.2:
A plant having a first cost of Rs 20,000.00 has an estimated salvage value of Rs
2000.00 at the end. Its useful life is 20 years. What will be the value of the plant
halfway its life:
(a) On the basis of straight line depreciation
(b) On a reducing balance basis
On a sinking fund basis as 6% interest compounded annually
Solution:
(a) Straight Line depreciation method
G = Rs 2000.00 after 20 years
Total depreciation, A' = A G = Rs 20,000.00 Rs 2000.00 = Rs18,000.00
A' Rs18000.00
=
= Rs900.00 per year
N
20
At the end of 10 years, the value will be= Rs 20,000.00- Rs 900.00x10=Rs
11,000.00
f =
1
G
log
N
A
194
Hence, f = 0.108
Value of the plant after 10 years=
10
10
A (1 f ) = Rs 20,000.00 (1 0.108 ) = Rs 6306.00
(c ) Sinking fund method
p=
Ai'
(1 + i )
N 1
0.06 Rs18,000.00
(1 + 0.06 )
20
= Rs 489.00
(1 + 0.06 )
= Rs 489.00
10
= Rs 6400.00
0.06
Value of the plant after 10 years is
= Rs 20,000.00 Rs 6400.00 = Rs13,600.00
A
'
Present value=
195
CF
1,00,000.00
1,00,000.00
1,50,000.00
Cumulative CF
1,00,000.00
2,00,000.00
3,50,000.00
CF
1,00,000
1,00,000
1,50,000
1,50,000
2,50,000
1
(1 + i )
1
(1 + i )
75,600.00
0.658
98,700.00
0.572
85,800.00
0.497
1,24,250.00
(1 + i )
0.756
(1 + i )
Total Present
value
87,000.00
(1 + i )
Present value at
15 %
0.87
Total Rs 4,71,350.00
196