Financing and Marketing Management

Unit 4- Fishery Financial Management

4.7. Discounted Pay Back Period
It is a simple method which estimates the length of the time required for an investment to pay back itself out, that is, the number of years required for a firm to cover its original investment from the net cash inflows. Although the period is easy to calculate, it can lead to erroneous decisions. As can be seen from our example, it ignores income beyond the payback period, & therefore is biased towards projects with shorter maturity periods. The payback period is sometimes used by investors who are short of cash and need to reinvest all cash flows that occur in early stages of the projects. Investors who are risk averse often use this technique in evaluating projects. Such investors need to receive cash at the early stages of projects since the future is uncertain. Thus, the payback period method is somewhat better reflection of liquidity than profitability.
Net Present Value
It is a discounted cash flow technique (DCF). It is the present value of net cash flow which are discounted at firm’s required rate of return on the stream of net cash. It is derived as sum of discounted cash flows minus the project’s initial investment. The NPV method uses the discounting formula of a non-uniform or uniform series of payments to value the projected cash flow for each investment alternative at one point in time.
An investment project would be accepted if the NPV>0 and rejected if NPV<0. This is because the money being invested is greater than the present value of the net cash flow. If NPV=0, the decision maker would be indifferent.
Benefit Cost Ratio
It is also called as Probability Index (PI). It is the ratio of present value of future net cash flows over the life of the project to the net-investment. The method usually produces the same result as the NPV in project evaluation, but it is very important in separating projects of varying sizes. If a project has a PI value greater than or equal to 1, (PI=1) it should be accepted and should be rejected if the PI value is less than 1.
Internal Rate of Return
It is the interest rate that will equate the sum of net cash flows to the initial investment. The interest rate that satisfies this equation is called internal rate of return (IRR). There is no way of finding the IRR. One is forced to use a systematic procedure of trial & error to find out the discount rate that will equate the net cash flows to the initial investment. Acceptability of project depends upon comparing the IRR with the investor’s required rate of return (RRR) sometimes called minimum acceptable rate of return (MARR). If IRR is greater than RRR (MARR), accept the project, if IRR is less than that, reject the project, if IRR=RRR be indifferent. The Excel spreadsheet has provision to estimate IRR.
IRR = Lower discount rate + (Difference between the lower and higher discount rate