In theory, we have that PP = Project’s Cost/Annual Income Money. That means if we have 1 billion to invest and per year we get 100 million, then after 10 years we can get back all the money we given before and 10 years is the payback period. However, this method has many disadvantages such as missing the time of money flow value and collected profit in the payback period. Therefore, in calculating we commonly use other indicators like NPV, IRR. When we use the financial indicator PP to assess the project, we learn that it has advantage is can determine when we can get all the money that’s given, but we cannot learn how many profit after completion of payback. Another important point that is if calculated payback period is larger than the time for investment, project is impossible for retrieve the money directly, that means we do not need to assess other indicators. In actual, PP can be calculated as bellow:
Look into the formula, it seems very difficult but if you complete the following exercise you can see it’s very simple than you though
A project invested from 2010 with annual given capital as bellow:
- Year 2010: 10 million USD
- Year 2011: 8 million USD
- Year 2012: 6 million USD
Exploited time is 10 years. Basically discount per year is 1.5 million USD constantly. Project exploited in 2011. Forecast interest is 1 million USD and next year increases 1.2 to previous year. Discount interest is 10%/year.
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