Payout

The point at which the cumulative cash flow turns positive indicates the payout time (or payback time). This is the length of time required to receive accumulated net revenues equal to the investment. This indicator says nothing about the cash flow after the payback time and does not consider the total profitability of the investment opportunity. 

The cumulative cashflow was used to derive ultimate cash surplus - the final value of the cumulative cashflow maximum exposure - the maximum value of the cash deficit payout time - the time until cumulative cashflow becomes positive. 

The shortcoming of the maximum exposure and payout time is that they say nothing about what happens after the cashflow becomes positive (i.e. the investment is recouped). Neither do they give information about the return on the investment in terms of a ratio, which is useful in comparing projects. 

This gives two choices ia interpreting calculated NRR values, ie, a direct comparison of NRR values for different options or a comparison of the NRR value of each option with a previously defined NRR cutoff level for acceptabiUty. The NPV, DTC, and NRR can be iaterpreted as discounted measures of the return, iavestment, and return rate, analogous to the parameters of the earher example. These three parameters characterize a venture over its entire life. Additional parameters can be developed to characterize the cash flow pattern duting the early venture years. Eor example, the net payout time (NPT) is the number of operating years for the cumulative discounted cash flow to sum to zero. This characterizes the early cash flow pattern it can be viewed as a discounted measure of the expected operating time that the investment is at risk. 

Another possibiUty is the net payout fraction (NPE), defined as the ratio of the NPT to the operating life of the venture. This is the fraction of the expected operating lifetime needed to recover the discounted investment. 

Payout time (PT), or payback period, is a measure of the time, usually in years, required to recover the investment in a scenario in which the time value of money is neglected. This can be represented by the general form... 

Problem Selection. To select the problem correcdy, the criteria discussed earHer should be carefully appHed before launching a project the existence of a knowledge bottleneck, the inappHcabiHty of exact numerical methods, the existence of either an expert or a theory for the task, the narrowness of the domain, and the business issues of payout and cost. If needed, the various criteria can be quantified and weighted based on their... 

Barnwell, J. and Wong, W., Expanders Do Payouts Offshore Nortli Sea, 5tli Offshore Southeast Asia, Singapore, Eebmary 1984. 

Caleulation of the payout period does not, however, take into aeeount the underlying eeonomies of eash flow. The interest ealeulated in Table 4-9 is the interest for the first year. Deelining interest over time direetly translate to inereased eash flow. To illustrate this situation, assume the useful life of this projeet is the same 15 years used for depreeiation. 

Once the cash flow has been calculated, various yardsticks can be applied to determine the desirability of the project. The years for payout (payback) is often used. This is obtained by adding the cash flow each year, from the first year of construction, until the sum of the negative and positive cash flows reaches zero. The payout is usually reported in years to the nearest tenth, i.e., 5.6 years. 

Each company has its own cutoff period for payout, depending on the economy, the company position, alternate projects, etc. One company used five years as the maximum payout acceptable for several years. As conditions changed, this w as reduced to three years, then one year. It was hai d to And projects with one year payout after taxes. 

Some companies feel they should earn interest on their equity as w ell as get a payout. To calculate this, the cash flows are discounted back to year 0 using some arbitrary interest (discount) rate, then the positive discounted cash flows are summed each year of operation until they equal the sum of the discounted negative cash flows. This yardstick also works but consistency must be maintained from one project to another. The discount (interest) rate and payout both become variables that must be set and perhaps changed from time to time depending on economic conditions inside and outside the company. 

If plant expansion is being studied with the idea of determining the best practical upper limit, the linear program can be a great help. Each incremental expansion step can be evaluated and payouts determined off line. Also, each piece of proposed new equipment can be evaluated as to its effect on the entire plant. 

There are various indicators to determine the measure of profit for a process. In the following, we describe two of these indicators return on investment and payout period. The rate of return on investment (ROI) may be calculated as follows ... 

Another profitability criterion is the payback (or payout) period which is defined as follows ... 

Prepare rough cost economics, including preliminary sizing and important details of equipment, factor to an order of magnitude capital cost estimate [34] (see also [19]), prepare a production cost estimate, and work with economic evaluation representatives to establish a payout and the financial economics of the proposed process. 

A company wants to make the largest profit it can from the money it invests. It wants to be able to compare the prospective earnings it may get from different ventures. Two of the simplest measures are the return on investment and the payout time. 

The payout time or payback period is the number of years from the time of startup it would take to recover all expenses involved in a project if all the pretax profits were used for this purpose. 

In determining profits for this case, no depreciation is included in the expenses. It is not necessary to assume a mature plant or to ignore startup expenses when using this method. Example 10-3 shows how to calculate the payout period for a plant that does not reach full production until the fourth year of operation. 

For the first three years the proceeds are 11, 000,000. After that it is 7,000,000/year. The years for payout =... 

Often, as in the case of the return on the investment, expenses not incurred directly in the design and construction of the plant are excluded when the payout period is calculated. If the only prestartup expense considered is the fixed capital investment, a payout time of 3-5 years is reasonable. A time longer than this is considered unacceptable. 

The problem with the payout period is that it does not consider the timing of the payments or the profits earned by the plant after the payout period is over. To illustrate the importance of the former, suppose a plant has the same prestartup expenses as the one in Example 10-3. Assume it has a profit of 5,000,000 per year for the first 5 years and from then on earns 7,000,000 per year. The payout time for this plant is 5 years, the same as for the plant in Example 10-3. The return on investment of the two mature plants is the same. Yet this proposed plant has a definite advantage over the one in Example 10-3. This is illustrated in the following example. 

The importance of profits after the payout period can be shown by making a small change in Example 10-4. Suppose that plant 2 made a profit in year 6 of 5,000,000 instead of 7,000,000 and everything else was the same. Then plant 1 would result in a pretax saving of 950,000 in year 6 and would be preferable. Neither the payback period nor the return on investment method would indicate this. 

The calculations of the return on the investment and payout period follow. Those for the Net Present Value and Rate of Return are given following Chapter 11. 

Estimate the working capital and determine the annual proceeds per dollar of outlay and the payout time for a plant producing melamine. Use the figures given in Chemical Week, Nov. 25, 1967, p. 78. These are duplicated below. Melamine sells for 26.50/lb. 

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