Tutorial Financial Model
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SITI ZULAIKA MUHD NASERTutorial Financial Model
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SITI ZULAIKA MUHD NASERCHAPTER 3 : Measurable Organizational Value and
the Business Case
TUTORIAL FINANCIAL MODEL
Payback Period
Payback period is the time in which the initial cash outflow of an investment is expected
to be recovered from the cash inflows generated by the investment. It is one of the
simplest investment appraisal techniques.
Formula
1. EVEN CASH FLOW
Initial Investment
Payback Period =
Cash Inflow per Period
2. UNEVEN CASH FLOW
In the formula,
B A is the last period with a negative
cumulative cash flow;
Payback Period = A + B is the absolute value of cumulative
cash flow at the end of the period A;
C
C is the total cash flow during the period
after A
Decision Rule
Accept the project only if its payback period is LESS than the target payback
period.
1
EXERCISE PAYBACK PERIOD
Example 1: Even Cash Flows
Company Tenang Enterprise is planning to undertake a project requiring initial
investment of RM105 million. The project is expected to generate RM25 million per
year for 7 years. Calculate the payback period of the project.
Solution
Payback Period = Initial Investment ÷ Annual Cash Flow = RM105M ÷ RM25M = 4.2
years
Example 2: Uneven Cash Flows
Company C is planning to undertake another project requiring initial investment of
RM50 million and is expected to generate RM10 million in Year 1, RM13 million in
Year 2, RM16 million in year 3, RM19 million in Year 4 and RM22 million in Year 5.
Calculate the payback value of the project.
Solution
(cash flows in millions) Cumulative
Year Cash Flow Cash Flow
-50,000,000 / (50,000,000)
0 (50) (50)
1 10 (40)
2 13 (27)
3 (A) 16 (11) (B)
4 19 (C) 8
5 22 30
B
Payback Period = A +
C
A= 3
= 3 + (RM11M (B) ÷ RM19M (C))
= 3 + (RM11M ÷ RM19M)
≈ 3 + 0.58
≈ 3.58 years
2
NET PRESENT VALUE
Net Present Value(NPV) is a formula used to determine the present value of an
investment by the discounted sum of all cash flows received from the project. The
formula for the discounted sum of all cash flows can be rewritten as
Example of Net Present Value
To provide an example of Net Present Value, consider company ZamZam who is
determining whether they should invest in a new project. ZamZam will expect to invest
RM500,000 for the development of their new product. The company estimates that the
first year cash flow will be RM200,000, the second year cash flow will be RM300,000,
and the third year cash flow to be RM200,000. The expected return of 10% is used as
the discount rate.
The following table provides each year's cash flow and the present value of each cash
flow.
Year Cash Flow Present Value
0 -RM500,000 RM500,000
1 RM200,000 RM181,818.18
2 RM300,000 RM247,933.88
3 RM200,000 RM150,262.96
Net Present Value = RM80,015.02
The net present value of this example can be shown in the formula
When solving for the NPV of the formula, this new project would be estimated to be a
valuable venture.
3
RETURN ON INVESTMENT
BREAK EVEN
Materials (putter head, shaft, grip, etc.) RM 12.00
Labor (0.5 hours at RM9.00/hr) RM 4.50
Overhead (rent, insurance, utilities, taxes, etc.) RM 8.50
Total RM 25.00
If you sell a golf putter for RM30.00 and it costs RM25.00 to make, you have a profit
margin of RM5.00:
Breakeven Point = Initial Investment / Net Profit Margin
= RM100,000 / RM5.00
= 20,000 units
4
INTERNAL RATE OF RETURN (IRR)
