Chapter 4 Evaluating A Single Project Payback and BC Ratio

Evaluating a Single
Project
Julius D. Obnamia, CIE, AAE, CLSSGB
The Payback Period Method
 One of the primary concerns of most business people is

whether, and when, the money invested in a project can
be recovered. The payback method screens projects one
the basis of how long it takes for net receipts to equal
investment outlays. This calculation can take one of two
forms by either ignoring time value of money
considerations of including them. The former case is
usually designated as the conventional payback method,
whereas the latter case is known as the discounted
payback method.
The Payback Period Method
 A common standard used to determine whether or not to

pursue a project is that a project does not merit
consideration unless its payback period is shorter than
some specified period of time. (This time limit is largely
determined by management policy.) If the payback period
is within the acceptable range, a formal project
evaluation (such as PW analysis) may begin. It is
important to remember that payback screening is not an
end in itself, but rather a method of screening out certain
obvious unacceptable investment alternatives before
progressing to an analysis of potentially acceptable ones.
Payback Period
 Conventional Payback Period Method
Initial cost
Payback Period =
Uniform annual benefit
Payback Period
 Discounted Payback Period Method

If the time value of money (i.e., the cost of
funds (interest) used to support the project) is
considered, the modified payback period is referred
to as the discounted payback period. In other
words, we may define the discounted payback
period as the number of years required to recover
the investment from discounted cash flows
Sample Problem
 A piece of new equipment has been proposed by an

engineer to increase the productivity of a certain manual
welding operation. The investment cost is Php250,000
and the equipment will have a market value of Php50,000
at the end of the study period of 5 years. Increased
productivity attributable to the equipment will amount to
Php80,000 per year after operating costs have been
subtracted from the revenue generated by the additional
production. If the firm’s MARR is 20% per year, is this
proposal a sound one? Use conventional and discounted
payback method to evaluate the economic soundness of
the investment.
The Benefit-Cost Ratio Method
 The benefit-cost (B-C) ratio is defined as the

ratio of the equivalent worth of benefits to the
equivalent worth of costs. The equivalent-worth
measure applied can be PW, FW, or AW, but
customarily, either PW or AW is used. The B-C
ratio is also known as the savings-investment
ratio (SIR) by some governmental agencies.
Benefit-Cost Ratio (B-C Ratio)
Conventional B-C Ratio
PW (Benefits of the Proposed Project)
B-C =
PW (Total Cost of the Proposed Project)
Modified B-C Ratio

PW(Benefits) - PW(Operating and Maintenance Cost)
B-C =
Initial Investment -PW(Market Value)
Benefit-Cost Ratio (B-C Ratio)
 The numerator of the modified B-C ratio

expresses the equivalent worth of the benefits
minus the equivalent worth of the operating and
maintenance costs, and the denominator includes
only the initial investment costs (less any market
value).
 A project is acceptable when the B-C ratio is
greater than or equal to 1.0.
Sample Problem
 A piece of new equipment has been proposed by an

engineer to increase the productivity of a certain manual
welding operation. The investment cost is Php250,000
and the equipment will have a market value of Php50,000
at the end of the study period of 5 years. Increased
productivity attributable to the equipment will amount to
Php80,000 per year after operating costs have been
subtracted from the revenue generated by the additional
production. If the firm’s MARR is 20% per year, is this
proposal a sound one? Use conventional and modified B-C
ratio method to evaluate the economic soundness of the
investment.
Assignment
 An initial capital of Php1,000,000 was put up for a new business

that will produce an annual income of Php600,000 for 5 years
and will have a salvage value of Php20,000 at the time. Annual
expenses for its operation (salaries and wages, insurance,
taxes) and maintenance amounts to Php300,000. If money is
worth 10% compounded annually, is this investment profitable
or not? Use each of the following methods in your evaluation.
a. Conventional Payback Method
b. Discounted Payback Method
c. Conventional Benefit-Cost Ratio Method
d. Modified Benefit-Cost Ratio Method

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Chapter 4 Evaluating A Single Project Payback and BC Ratio

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Evaluating a Single

 One of the primary concerns of most business people is

 A common standard used to determine whether or not to

 Conventional Payback Period Method

 Discounted Payback Period Method

 A piece of new equipment has been proposed by an

 The benefit-cost (B-C) ratio is defined as the

Modified B-C Ratio

 The numerator of the modified B-C ratio

 A piece of new equipment has been proposed by an

 An initial capital of Php1,000,000 was put up for a new business

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