#2 Payback Period - Investment Decision - Financial Management ~ B.COM / BBA / CMA

Saheb Academy・2 minutes read

The video focuses on capital budgeting techniques, specifically the payback period, to determine how quickly an initial investment can be recovered through project cash inflows. It illustrates the concept with a calculation example and emphasizes that projects with longer payback periods are less favorable, using a practical problem-solving scenario to recommend the machine with the shortest payback period.

Insights

  • The payback period technique in capital budgeting evaluates how fast an initial investment can be recouped through project cash inflows, with projects over 3-4 years being less desirable.
  • Using the payback period method, decision-makers can compare investment options based on the time it takes to recover the initial investment, favoring shorter payback periods for quicker returns.

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Recent questions

  • What is capital budgeting?

    The process of evaluating long-term investment decisions.

  • How is the payback period calculated?

    By dividing the initial investment by annual cash inflow.

  • What does a longer payback period indicate?

    Less favorable investment option.

  • How is the payback period used in decision-making?

    To recommend projects with shorter payback periods.

  • Why is cumulative cash flow analysis important in determining the payback period?

    To accurately calculate the payback period when cash inflows are not equal.

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Summary

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Capital Budgeting Techniques: Payback Period

  • This video is the second part of the investment decision chapter, focusing on capital budgeting techniques.
  • The first video covered an overview of the chapter and the process of capital budgeting.
  • The current video delves into the first technique of capital budgeting, the payback period.
  • The payback period technique assesses how quickly the initial investment can be recovered through project cash inflows.
  • A simple formula for calculating the payback period is initial investment divided by annual cash inflow.
  • An example with an initial investment of 100 rupees and annual cash inflows of 20 rupees for 7 years illustrates the concept.
  • Projects with longer payback periods, exceeding 3-4 years, are considered less favorable.
  • A practical problem-solving scenario presents two machine options, A and B, with different initial investments and cash inflows.
  • The payback period method is used to recommend the machine with the shorter payback period, indicating quicker investment recovery.
  • When cash inflows are not equal, cumulative cash flow analysis is necessary to determine the payback period accurately.
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