Simple Payback (E)
What is the project? How to select and justify the project? How to plan and execute the project?
Posted: Sep 2010
Simple payback method is used in project management for selection and filtering of projects list. Example: the company is considering several projects for funding during the next budget year. Project A is for a new machine that costs €2,000. The company’s policy for a payback period is two years for any capital projects. The new machine will generate €2,000 in positive cash flow for each year.
Payback period = €2,000 / €2,000 = 1,0 year
In this particular case, the initial investment will be recovered in 1 year, which is well within the two-year payback period policy of the company. Since this project has a high payback potential, the company will add Project A to its list of possible projects. Companies usually do not use this method to aprove the project. They use it to eliminate any projects that fall outside the company’s desired payback period.
This method does not take into consideration the time value of money. Also, return on investment after the payback period is not taken into account. In case that cash flow is expected to change from year to year (e.g., changes in sales volume ), the procedure is more complex and involves additional investment during the payback period (e.g., upgrades, expansions ).
Financial method that compares the initial investment with the length of time necessary to recover the initial investment. This method does not take into account the time value of money.
Quick method used to eliminate the projects that do not fit the company’s general guidelines of a payback period for capital projects during the first pass of the capital budget.
Continue on Project Management:
1. Project Management Overview
2. 9 Areas of Project Management
3. Project Lifecycle – 5 Stages of Project
4. How to Determinine a Value of the Project?
4.1. Simple Payback
4.2. Average Return on Investment (ROI)
4.3. Net Present Value (NPV)
4.4. Internal Rate of Return (IRR)
4.5. Cost/benefit analysis
4.6. Time value of money
4.7. Present value of future payments
4.8. Justification of Addopted project
5. Project Planning – Project Charter
6. Work Cascading Structure (WBS)
7. Project Scheduling ( Arrow-on-Arrow and Gantt Chart )
8. Project Scheduling ( CPM and PERT )
9. The Responisbility Matrix
10. Resources and Budget Planning
11. Clasification of Projects