W10_ANG_Payback Period for Student Pick-up Service

Problem Statement

Following my previous blog posting, on this posting I would discuss about Payback Period of Student Pick-up Service Business. I would simulate the payback calculation to determine the decision of funding scheme based on payback period of investment. On this posting, I put three scenarios: 1^st is fully using equity fund, 2^nd is using mixed equity and debt which ten million rupiah of investment (21.74%) is using debt and 3^rd is also mixed which forty million rupiah of investment (86.96%) is using debt.

Feasible Alternatives

The feasible alternatives are 1^st: using full equity, 2^nd: mixed fund with 21.74% of investment using debt and 3^rd: mixed fund with 86.96% of investment using debt.

Both simple payback period and discounted payback period are calculated below to know the sensitivity when time value of money is considered.

Outcomes/ Calculations

Scenario 1

Scenario 2

Scenario 3

Setting Minimum/ Selection Criteria

The minimum criterion is at the end of investment time horizon, the payback period of investment must be fulfilled.

Then for this case, the early payback period achieved the better.

Analysis/ Comparison of the Alternatives against the Criteria

Compare to above calculation:

For simple payback period: the earliest is scenario 1: 23 weeks

For discounted payback period: all has the same: 24 weeks

Selection of the Best/ Preferred Alternative Compared against the Criteria

Above calculation shows that the funding scheme does not impact on payback period.

So the chosen of funding scheme should not base on payback period calculation.

Performance Monitoring and Post Evaluation of Result/ Follow up Assessment

Payback period mainly only indicate a project liquidity rather than its profitability, since liquidity deals with how fast an investment can be recovered.

This can be misleading if one alternative project has a longer (less desirable) payback period than another but produces a higher rate of return on the invested capital.

That’s why recommended not to use payback period to make investment decision but as a secondary measure how quickly invested capital will be recovered.

References:

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