Payback Period: Initial Investment / Cash Flow Per Period

Payback
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Payback
Investment criteria refers to a defined tool or a financial parameters that are used by investors and strategic buyers to determine, assess and calculate acquisition opportunities. Therefore, the paper explores in detail into the typical investment criteria, which include include; Payback Rule, Discounted Payback Rule, Net Present Value (NPV), Internal Rate of Return (IRR), and Modified Internal Rate or Return (MRR). Also, the paper examines the the weaknesses of each investment criteria.
Payback Rule
Payback rule is a criteria that focuses on determining the amount of time (payback period) that will take for a particular investment to yield back returns (Vance, 2013). In other words, it simply means the time taken for and investor to recover the initial cost of investment from the cash inflows generated by investment (Vance, 2013). The formula for calculating the payback period primarily depends on whether the investment is generating even cash inflows or not. In case the cash inflow are even, the period is calculated as:
Payback Period = Initial Investment / Cash Flow per Period
In case the cash inflows are uneven, it is necessary to consider the varying and calculate the cumulative net cash for each period (Parrino & Kidwell, 2012). Thus, under such as situation, I t is calculated as;
Payback Period = A + B/C
Where:
A is the last period with and adverse cumulative cash flows
B is the absolute value of cumulative cash flow at the end of period A
C is the the total cash flows accumulated between the period after A
Basing on the answer of the payback period, an investor can decide to accept only if investment project is payback period less than the expected payback period (Vance, 2013).
Discounted Payback Rule
Discounted Payback Rule is used to determine the period needed to recoup the initial cost of a project based on the periodic cash inflows (Brigham & Ehrhardt, 2016). The concept applies by discounting the cash inflows at each period to factor the time value of money effect (Brigham & Ehrhardt, 2016). This method is mostly used in capital budgeting to analyse and compare between projects, initial outlay and the recovered amount. It is calculated as:
Discounted Payback Period = In {1/ (1 – O1× R /CF) ÷ In (1 + r)
Where:
O1 = Initial Investment cost
R= is the rate
CF = Period cash flow
Net Present Value (NPV)
NPV refers to an investment measuring tool that is used by investors to determine whether a project will realize profit at a given cost of investment over a period of time. NPV can also be used in the measure the changes in initial investments when targeting to meet better yields provided all aspects remain the same (Brigham & Ehrhardt, 2016). It is calculated by summing up the cash inflow in each period over a specific period of time and discounted at a given period of time of required rate of return or return (Brigham & Ehrhardt, 2016).
The basic con...