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124 Financial Management
Solution
Profit after depreciation 3,00,000
Tax 50%
1,50,000
1,50,000
Add depreciation
1
20,00,000 12
2% 2,50,000
Cash in flow 4,00,000
Pay-back period = Investment
Cash flow
= 20,00,000
4,00,000 = 5 years.
Uneven Cash Inflows
Normally the projects are not having uniform cash inflows. In those cases the pay-back
period is calculated, cumulative cash inflows will be calculated and then interpreted.
Exercise 3
Certain projects require an initial cash outflow of Rs. 25,000. The cash inflows for 6
years are Rs. 5,000, Rs. 8,000, Rs. 10,000, Rs. 12,000, Rs. 7,000 and Rs. 3,000.
Solution
Year Cash Inflows (Rs.) Cumulative Cash Inflows (Rs.)
1 5,000 5,000
2 8,000 13,000
3 10,000 23,000
4 12,000 35,000
5 7,000 42,000
6 3,000 45,000
The above calculation shows that in 3 years Rs. 23,000 has been recovered Rs. 2,000, is
balance out of cash outflow. In the 4th year the cash inflow is Rs. 12,000. It means the
pay-back period is three to four years, calculated as follows
Pay-back period = 3 years+2000/12000×12 months
= 3 years 2 months.
Post Pay-back Profitability Method
One of the major limitations of pay-back period method is that it does not consider the cash
inflows earned after pay-back period and if the real profitability of the project cannot be
assessed. To improve over this method, it can be made by considering the receivable after
the pay-back period. These returns are called post pay-back profits.