1.
Investment Analysis: Payback Period and NPV Methods
Problem Statement
A company is evaluating two mutually exclusive projects — Project A and Project
B. Each requires an initial investment of ₹60,000. The expected cash inflows over
the next 5 years are as follows:
Year Project A (₹) Project B (₹)
1 15000 10000
2 15000 20000
3 15000 25000
4 15000 15000
5 15000 10000
1. Calculate Payback period
2. Net profit
3. ROI
4. NPV
Solution
Given:
Initial Investment: ₹60,000 (for both projects)
Cash inflows over 5 years:
Project A Project B
Year
(₹) (₹)
1 15,000 10,000
2 15,000 20,000
3 15,000 25,000
4 15,000 15,000
5 15,000 10,000
Assume Discount Rate (for NPV): 10% (unless stated otherwise)
1. ✅ Payback Period
Payback period = Time taken to recover the initial investment from cash inflows.
▶ Project A:
Cumulative inflows:
Year 1: ₹15,000
Year 2: ₹30,000
Year 3: ₹45,000
Year 4: ₹60,000 → Recovered in Year 4
✅ Payback Period = 4 years
▶ Project B:
Cumulative inflows:
Year 1: ₹10,000
Year 2: ₹30,000
Year 3: ₹55,000
Year 4: ₹70,000 → Recovered during Year 4
To find the exact time:
Remaining = ₹5,000 after Year 3
Year 4 inflow = ₹15,000
Fraction of year = ₹5,000 / ₹15,000 = 1/3
✅ Payback Period = 3 + 1/3 = 3.33 years
2. ✅ Net Profit
Net Profit = Total Cash Inflows – Initial Investment
▶ Project A:
Total Inflows = ₹15,000 × 5 = ₹75,000
Net Profit = ₹75,000 – ₹60,000 = ₹15,000
▶ Project B:
Total Inflows = ₹10k + ₹20k + ₹25k + ₹15k + ₹10k = ₹80,000
Net Profit = ₹80,000 – ₹60,000 = ₹20,000
3. ✅ ROI (Return on Investment)
ROI = (Net Profit / Initial Investment) × 100
▶ Project A:
ROI = (15,000 / 60,000) × 100 = 25%
▶ Project B:
ROI = (20,000 / 60,000) × 100 = 33.33%
4. ✅ NPV (Net Present Value at 10%)
We discount each year’s cash inflow using PV factor = 1 / (1 + r)^n, where r =
10%.
Year PV Factor @10% Project A PV A Project B PV B
1 0.909 15,000 13,635 10,000 9,090
2 0.826 15,000 12,390 20,000 16,520
3 0.751 15,000 11,265 25,000 18,775
4 0.683 15,000 10,245 15,000 10,245
5 0.621 15,000 9,315 10,000 6,210
56,850 60,840
▶ Final NPV:
Project A NPV = 56,850 – 60,000 = –₹3,150
Project B NPV = 60,840 – 60,000 = ₹840
2. ROI and NPV Calculation for Uneven Cash Flow Project
Problem Statement
A company is considering a project with an initial investment of ₹50,000. The
expected cash inflows over the years are as follows:
Year Cash Inflow (₹)
1 12000
2 14000
3 10000
4 8000
5 6000
Let’s calculate the ROI and NPV for the uneven cash flow project.
✅ Given:
Initial Investment = ₹50,000
Cash Inflows:
Year Cash Inflow (₹)
1 12,000
2 14,000
3 10,000
4 8,000
5 6,000
Total Cash Inflow = ₹12,000 + ₹14,000 + ₹10,000 + ₹8,000 + ₹6,000 = ₹50,000
Assume Discount Rate = 10% for NPV calculation
✅ 1. ROI (Return on Investment)
Formula:
ROI=(Net Profit / Investment)×100
Net Profit = Total inflow – Initial Investment
= ₹50,000 – ₹50,000 = ₹0
👉 ROI = (0 / 50,000) × 100 = 0%
🟡 No gain or loss, just breakeven.
✅ 2. NPV (Net Present Value)
Formula:
NPV=∑(Cash Inflow / (1+r)n)−Initial Investment
Where r = 10% (0.10)
Year Cash Inflow (₹) PV Factor @10% Present Value (₹)
1 12,000 0.909 10,908
2 14,000 0.826 11,564
3 10,000 0.751 7,510
4 8,000 0.683 5,464
5 6,000 0.621 3,726
Total PV = ₹39,172
Now,
NPV=₹39,172−₹50,000=–₹10,828
3. Problem Statement
A company invests ₹40,000 in a project that is expected to generate annual cash
inflows of ₹10,000 for 5 years. The discount rate is 10%. Calculate the Return on
Investment (ROI) and Net Present Value (NPV).
✅ Given:
Initial Investment = ₹40,000
Annual Cash Inflows = ₹10,000 (for 5 years)
Discount Rate (r) = 10%
✅ 1. Return on Investment (ROI)
Formula:
ROI=(Net Profit / Investment)×100
Total Inflows over 5 years:
₹10,000×5=₹50,000₹10,000 \times 5 = ₹50,000₹10,000×5=₹50,000
Net Profit = ₹50,000 – ₹40,000 = ₹10,000
ROI=(10,00040,000)×100=25%
✅ 2. Net Present Value (NPV)
Formula:
NPV=∑(Cash Inflow / (1+r)n)−Initial Investment
Using PV factor @10% for each year:
Year Cash Inflow PV Factor @10% Present Value
1 ₹10,000 0.909 ₹9,090
2 ₹10,000 0.826 ₹8,260
3 ₹10,000 0.751 ₹7,510
4 ₹10,000 0.683 ₹6,830
5 ₹10,000 0.621 ₹6,210
₹37,900
NPV=₹37,900−₹40,000=−₹2,100
🔍 Summary:
Metric Value
Initial Investment ₹40,000
Total Inflows ₹50,000
Net Profit ₹10,000
ROI 25%
–
NPV @10%
₹2,100
📌 Interpretation:
ROI of 25% indicates a nominal gain.
But a negative NPV means the project's returns do not meet the 10% required rate of
return.
So, it may not be considered a value-adding investment if 10% is the benchmark.
