The calculation of the project's payback in this scenario is based on the ratio of total capital costs and the projected gross profit from operating the new equipment:
Payback period of equipment = Capital investment / Expected average gross profit for the period
Investments include all costs associated with putting t3 phone number identifier philippines he equipment into operation: the cost of the equipment itself, costs of transportation, installation, adjustment, and personnel training.
Expected Average Gross Profit for the Period = (Product Price – Product Cost) × Average Quantity of Products for the Period
Example: a café owner who previously purchased bread decides to increase the competitiveness of the establishment by installing his own bakery. Investments in equipment amount to 250,000 rubles. The planned production volume is 1,000 loaves per month, the selling price is 30 rubles, the cost price is 5 rubles per loaf.
Indicators: 250,000 / ((30 - 5) × 1000) = 10 months.
Additional calculations of project payback
In addition to the basic calculation formulas, there are several other indicators.
Profitability index as an indicator of the return on investment of an investment project
The Profitability Index (PI) is a key indicator that reflects the ratio of the present value of future cash flows to the initial investment. When PI > 1, the project demonstrates a positive return on investment and is worth investing in.
If PI = 1, the project is on the verge of breakeven. If PI < 1, investments are not advisable due to negative payback.
PI is recommended to be used as an auxiliary criterion for assessing the payback of a project, especially when comparing investments with identical NPV.
Calculating the project's payback using PI is especially effective when the investment budget is limited, allowing you to determine the most profitable investments.
Formula:
PI = PV ( CF +) / PV ( CF -)
This formula represents the ratio of the sum of discounted positive cash flows (PV CF+) to negative ones (PV CF-), which allows us to determine the payback period of the project and its effectiveness.
Internal rate of return of a project
Internal Rate of Return (IRR) is a critical indicator that determines the maximum level of costs at which an investment remains profitable.
Internal rate of return of a project
Source: shutterstock.com
Companies attract capital from various sources, offering investors dividends and other forms of remuneration. At the same time, businesses need to maintain their economic potential, including by upgrading their production facilities. These costs form the price of advanced capital (capital cost).
Payback assessment and investment decisions are based on a comparison of the project's profitability level with the current cost of the capital advanced.
To determine the feasibility of investments, IRR is compared with the standard profitability. The higher the IRR and the greater its prevalence over the discount rate, the stronger the financial stability of the project.
IRR is the discount rate at which the net present value (NPV) of a project is zero. An increase in IRR indicates an increase in the project's risk tolerance. If the IRR is below a threshold, investing is not advisable.
Formula for calculating IRR:
0= NPV = t =1∑ T (1+ IRR ) tCt − C 0
Where:
St = net cash flow for the period.
tС0 = total initial investment.
IRR= internal rate of return.
t= number of time periods.
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Modified Internal Rate of Return (MIRR)
The assessment of the project's payback is often based on the IRR indicator. However, this method has a significant drawback: the discount rate varies during the calculation, which leads to the use of hypothetical values.
It is assumed that the investor's potential income varies not only within the project under consideration, but also across all alternative investments. This may lead to an overestimation of the projected return.
Modified Internal Rate of Return (MIRR)