Principles of Managerial Finance

CHAPTER 9 Capital Budgeting Techniques 397

payback period
The amount of time required for a
firm to recover its initial invest-
ment in a project, as calculated
from cash inflows.

0

$42,000

End of Year

Project A

$14,000

1

$14,000

2

$14,000

3

$14,000

4

$14,000

5

0

$45,000

End of Year

Project B

$28,000

1

$12,000

2

$10,000

3

$10,000

4

$10,000

5

FIGURE 9.1

Bennett Company’s
projects A and B
Time lines depicting the
conventional cash flows of
projects A and B

LG2

sider cash flows and the time value of money, it is ignored here. The PI, sometimes called the benefit–cost ratio,is

calculated by dividing the present value of cash inflows by the initial investment. This technique, which does con-

sider the time value of money, is sometimes used as a starting point in the selection of projects under capital

rationing; the more popular NPV and IRR methods are discussed here.

Review Question

9–1 Once the firm has determined its projects’ relevant cash flows, what must

it do next? What is its goal in selecting projects?

9.2 Payback Period

Payback periods are commonly used to evaluate proposed investments. The

payback periodis the amount of time required for the firm to recover its initial

investment in a project, as calculated from cash inflows.In the case of an annuity,

the payback period can be found by dividing the initial investment by the annual