In order to assess the economic efficiency of investments, expected when buying an operating company or expanding an existing business, you have to take into account many indicators. One of these parameters is the payback period, that is, the period of time for which the investment costs will be fully reimbursed.
Instructions
Step 1
Consider a formula that will help you calculate the correct return on investment. It includes the payback period, the number of years preceding the payback year, the unreimbursed cost at the beginning of the payback year, the cash flow for the payback year of the project:
T = T '+ S / N; Where
T is the payback period of the investment project;
T ’- the number of years preceding the payback year;
S - unrecovered cost at the beginning of the payback year;
N is the amount of cash for the year of payback of the project.
Step 2
Consider, as an example, the method of calculating the payback period using the example of a hypothetical investment project. Suppose this project requires an investment of 10,000 conventional monetary units. The following sequence of indicators is planned as a forecast of income by years: the first year - 2000 conventional monetary units; second year - 5000 units; third year - 6,000 units; fourth year - 8000 units; at the end of the fifth year, the income will be 9000 conventional currency units. The discount rate is assumed to be 15 percent.
Step 3
Apply a time-based cash flow valuation technique. If you use a simple statistical method, then in this example the investment would pay off in two and a half years. However, simplified calculations do not take into account the rate of return on investment in a particular area of production. Therefore, adjustments will have to be made to the payback calculation.
Step 4
Calculate the discounted income stream for the investment project in question. In doing so, take into account the period when incomes arise and the discount rate, which is 15%.
Step 5
Calculate what the accumulated cash flow will be. It is made up of a simple cost and revenue stream for the project.
Step 6
Calculate the discounted cash flow until you get a value with a positive status.
Step 7
Use the formula in step 1 to calculate the ROI. You will see that it will take more than three years for a real return on investment for the project, taking into account the time factor, that is, significantly more than is obtained when calculating using a simple statistical calculation method.
