1. Return on Investment – Payback Method By R. S. Miolla

2. Agenda 1) What is return on investment (ROI)? 2)One method of ROI, the Payback Method.

3. 1) What is ROI? Also called a capital budgeting decision. Invest now, get return later. Return is cash inflow. Simple case: Invest $3 million, cash inflows of $4 million => (inflow-investment)/investment => 1M/3M =.33 or 33% ROI.

4. 1) ROI or Capital Budgeting A long-term investment – Example: buying equipment, opening a plant Based on cash flows, not earnings – Statement of cash flows not the income statement

5. 2) Payback Method Computes how long until paid back. Does not use the time value of money. Ignores cash flows after payback. Easy to compute and understand.

6. Investment Defined $10,000 cash outflow (investment) Cash inflows: » Investment AInvestment B Year 160002000 240002000 3 20002000 4 05000 5 010,000

7. Payback Method Investment A: 10,000 – 6000 = 40001 year 4000 – 4000 = 02 years to payback Investment B: 10000 – 2000 =80001 year 8000 – 2000 = 60002 years 6000 – 2000 = 40003 years 4000 – 5000 = -1000 so 4000/5000 =.8 years, 3.8 years to payback

8. Summary Payback is one method for computing ROI. It computes time to payback. Easy to compute and understand. It does not use time value. It ignores flows after payback.