Payback Period Method - Explained in Hindi - YouTube

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Namaskar, my name is Mukul and welcome to Asset Yogi.

Where we unlock the knowledge of Finance.

In this video, we are going to talk about Payback period.

Playback period is 1 metric that tells whether we should invest in a project or not

and helps to evaluate a project.

NPV and IRR also are metrics,

By which we evaluate any project or business

or any investment whether we should invest money somewhere or not.

So payback period is also a similar metric,

so what is payback period, what is its concept,

how is it calculated,

what is Discounted payback period,

we will understand all these things in this video.

Its calculation will also see how we can do it manually

and how the calculation is done in Microsoft Excel.

Also, we will also discuss the benefits and limitations of Payback period,

And is it really a good method to evaluate any project or investment?

So all these things we will understand in this video.

And you must watch this video from beginning to end,

let's go straight to Blackboard.

So let us first understand what is Payback period,

why do we calculate it,

then payback period means how soon our money will be returned in any investment

or in some project

if i give an example,

So suppose you have invested ₹ 5 lakh in a project,

and your money returns within 3 years.

this means the investment or project that gives a 100% return.

within 3 years.

So if you had made this initial investment of Rs 5 lakh,

it will be returned in 3 years,

then your payback period is 3 years.

Now why do we calculate this,

so basically, the sooner our money comes back,

the sooner we can redeploy it, reuse it, invest money in any other investment.

And we can multiply our money as fast as possible.

So if we want to analyze a project, then whatever is our required time period,

if the payback period is less than that then we can accept that project.

For example if we think that if my money is returned in 5 years

from any investment then that investment is right for me

and payback period according to me should be less than 5 years.

So every company takes its own calculation, depends on each investment,

depends on the project, depends on the business,

so every company can decide the mark of a payback period for different projects.

So if suppose the payback period is less than the mark.

So money can be invested in that project.

Then if two projects are to be compared or 10 projects are to be compared

then whichever is the lowest payback period

whichever returns your money first,

You can also choose such a project.

But is this the best way to evaluate a project or business or investment?

Or is there any better method,

Or which is the best method to evaluate a project or investment.

Now before we will understand that thing, we have to understand its calculation.

Or is there any flaw in it,

we will understand from the calculation.

So let's understand its calculation with an example.

Suppose this is a car owner, he owns a car rental company.

this is Hiralal ji

he is wearing a Suit, he doesn't look like a Hiralal ji,

but he has worked hard to set up his Car Rental company,

he have worked hard in his business,

And he always checks payback period before buying any vehicle

he always make sure that he gets returns within 5 years,

his payback should be less than 5 years.

If we take an example let's say he want to invest in a vehicle.

Deciding a new route whether to invest money in it or not,

a car if he drives on that route,

So there comes an investment of Rs 10 lakh.

if we take out its cashflow of 5 years,

so, it comes somewhere around this,

For example, if he invests ₹ 10 lakh,

he will get a Net Cash flow of 2.5 lakh rupees for the next 5 years.

this is a Net cash flow here, I also write here NCF.

Net cash flow is the amount of money that is left after removing all your operational expenses,

that is 2.5 lakh rupees every year.

Now if he want to check his payback period,

then in such cases, where net cash flow is the same in every year.

if every year's return is 2.5 lakh rupees,

So calculating payback period is very easy in such case.

So what will you do to calculate the payback period,

whatever your investment is getting in this case is Rs 10 lakh.

Divide it as much as you are getting your money back in 1 year.

So here you will divide that by 2.5 lakhs.

So in this case, let's say your payback period is 4 years.

So because their payback period is 4 years,

is less than their estimate of 5 years.

so he can invest money in it.

After that, suppose the cashflows were different,

So how do we calculate payback period?

let's say 1.5 lakh rupees is the returns in the first year of this project,

and the traffic may gradually increase on the route

The vehicle that is that is idle in the beginning and gradually

the traffic increases or its utilization increases.

it would have earned 2 lakh in the second year,

2.5 lakh in the third year, 3 lakh in the fourth year, and

3.5 lakh in the fifth year, if it earn,

In such a case, how will we calculate the playback period,

so first of all, you will be adding all these Net cash flows.

So in 1.5 lakh, you add 2 lakh.

So now here you are basically taking out cumulative Cash flow,

I write CCF here,

So Here's you have Cumulative Cash Flows,

So you started adding here, there were one and a half lakhs,

you added 2 lakh so you get 3.5 lakh by 2nd year.

Then you add two and a half lakhs more,

then 3.5 lakhs plus 2.5 lakh have become 6 lakhs here.

I'll keep writing here,

So here comes 3.5,

Here is comes your ₹ 6 lakh,

Here you have added three lakh more, So here it becomes ₹ 9 lakh

So here you have seen that ₹ 3.5 lakh is coming within the fifth year.

So here you need ₹ 1 lakh more somewhere,

So 10 - 1 then if you had investment of 10 lakh rupees,

then you need ₹ 1 lakh more to recover

so your 10 lakh will be completed.

Then how will we calculate it then your payback will be,

it's will be 4 years old till here,

We have to calculate this period,

So how many years will be 4 plus here

this is your 3.5 lakhs

If it is coming within 1 year,

then 3.5 lakhs is coming within a year.

So, your 1 lakh will come in how much time

you will divide 1 by 3.5,

Your money will be returned within this many years, which is the amount of 1 lakh,

So if you calculate it you will understand that you will get the return in 0.29 years,

So you would do 4 + 0.29 here

your money will be back within these years,

So 4.29 years becomes payback period in this case.

So, it is less than 5 years, then Hiralal ji can invest money in it.

So this is the way to calculate a Payback period manually,

Now we will see this in Excel also,

But before that let us understand its flaws.

If we talk about the advantage of payback period

So its biggest advantage is

This is simple and quick calculation,

you can calculate very quickly,

In facts can calculate in your mind that if you know how much money comes

a amount of money I get from a project or investment every year,

then how quickly my total money Will come back

it becomes a very quick calculation,

But it also has a lot of disadvantages.

So the first disadvantage is that it's ignoring the time value of money.

So now that you are earning 3 lakh after 4 years or after 5 years you are earning 3.5 lakhs,

if we are saying 3.5 lakhs in today's date

So after 4 years, its value will not be ₹ 3 lakh

Or after 5 years its value will not be ₹ 3.5 lakh.

because inflation will continue to rise

Or if you earn returns of 10 to 15 percent out of that money,

then there is also the opportunity cost of capital,

that returns you are foregoing.

So we are directly calculating that after 4.29 years,

will get our 10 lakh back but we didn't put the time value of money in it.

the 1.5 lakh we are getting after 1 year, its actual value would not be 1.5 lakh

it will be less, maybe its value will be Rs.1,30,000.

So in 5 years the present value of every money will be reduced,

So that thing we discount in it, it is not calculated within this.

Secondly, the cash flow which we are taking only for 5 years or 4 years in Payback period

but this car which is being bought can earn till 10 years,

we haven't even discussed the cashflow for the next 5 years.

Further cash flows that occur within the payback period may be very high,

For the next 5 years, it may be possible that the vehicle will continue to earn 3.5 to 4 lakh every year.

So that thing is being ignored in it,

then the third thing is quite an arbitrary number.

it should be 3 years payback period or should be 4 years or should be 5 years or should be 10 years,

now this is quite an arbitrary number may be

a different number for everyone in the same project,

so the person says I am fine with getting my money back in 4 years,

So it can be a different number for everyone. It becomes quite arbitrary

so if this is not the right way

then what is the right way to evaluate a project or investment.

So if you have to calculate playback period only then it

becomes very quick calculation by definition so if you spend less money somewhere

let's say there is a small investment,

in such a case you can definitely calculate the payback period,

you get an estimate but better metrics are NPV and IRR.

Net Present Value and IRR basically means Internal Rate Return,

then this IRR calculates your returns and gives you, suppose in it,

what will be the annual rate of return for 5 years,

15% or 12 % it calculates it,

Net Present Value basically tells you how much value you are getting additionally,

how much value is going to be added from that project within your company.

So I have made many detailed videos on them, you must watch that video.

After that, if we want to calculate the payback period,

then we should calculate the discounted playback period

then whatever value it is,

we have to bring the value of 1.5 lakhs to the present value,

we have to bring the value of 2 lakh here we have to bring the value of 2.5 lakhs here,

3 lakh here and 3.5 lakh here,

After that, when this present value is calculated, then if we calculate our payback period,

then it will be a very good estimate.

How the health discounted payback period is calculated in the account,

we will now see it in the Excel sheet.

After that if you use a combination of NPV and IRR

and get discounted payback period of any project.

If you use the combination,

then you will get a very good idea about which project to invest in or not.

So let's see how this calculation is done in Excel,

first we look at calculating the payback period,

after that we will see how we calculate the discounted payback period.

So, first of all we will plot these cash flows year wise,

I have put this 10 lakh investment in zero as negative,

rest I have put positive Net cash flow year wise for 5 years

After that what we will do we will calculate the balance

balance means that we will calculate the amount of money we have to recover here every year.

we have to recover 10 lakh here so I will select this cell here i.e. =10 lakh.

after that =10,00,000 + 1.5 lakh is recovered so how much is left,

now 8.5 lakh are remain to recover,

So in this way, we will calculate year wise,

I selected 8.5 lakh here,

and I added 2 lakh here which were recovered in 2nd year,

so now 6.5 lakh remain to recover,

Now we will copy this whole formula till the last,

so as we selected the cell it will select the cells,

Look, we are getting positive in year 5,

so finally 1 lakh remains to recover within 4 year,

So how do we calculate the formula for the payback period,

If you take the year before the year in which your recovery is becoming positive,

then you will write that year here.

4 +

now, what you will do now you have to recover this ₹ 1 lakh,

then you have to calculate that in how many years you will recover this amount,

So you open the bracket and enter negative value

Basically, we will negat this negative value

so we have to recover ₹ 1 lakh divided by ₹ 3.5 lakh you are getting in year 5,

So you will select this cell here,

then you will recover ₹ 1 lakh in this time.

So we've got this G4 divided by H3,

So if you enter then see as we had calculated manually within 4.29 years,

your money will be recovered, in this way you can calculate your payback period

Now comes the Discounted Payback period,

What will we do in the discounted payback period

that after 1 year we will get 1.5 lakh,

we will have to calculate its present value of today;s date

So what does it mean that in today's date if suppose

I invest some money by 10%, it will have a value of 1.5 lakh rupees in its future,

so how much money should I invest in today's date?

According to the 10 %,

that it becomes 1.5 lakh rupees in the future, we will now calculate the value

10% is our discount rate,

so it is the reverse of the interest rate,

then if I can earn 10% returns on any investment in today's date,

So I'll take that same discount rate,

Now we will take the present value of all this,

like ₹ 2 lakh, how much money I must invest today that it becomes ₹ 2 lakh after 2 years,

How much money I must invest today so that after 3 years it becomes 2.5 lakh rupees,

then we will find out all that present value.

So here the present value of 10 lakh is the same in today's date,

so we select the same cell.

Now we will apply here the formula of PV of present value, and open the bracket,

your rate is 10%,

so, I'll put 0.1, then it is asking for the number of period ,

So if this period was your investment for 1 year

then we would put 1 here because this year 1,

after this the payment is getting zero in this case,

now I have already explained in a very detailed video the formula

of present value you must watch that video too,

Then in negative we have to enter future value

then you will close the bracket,

and enter then it is your present value

So if you invest Rs 136364 in today's date

then it will become 1.5 lakh rupees after 1 year.

similarly now we have to figure out all this present value

so firstly, I will copy this complete formula,

See what I have done till year 6 I have taken cash flows here,

Because I already calculated and saw that it is not happening within 5 years,

it is not coming positive,

So the payback period in this case is going more than 5 years,

So that's why I have taken this 6 year cash flow,

and I have assumed that after 5 years the car will earn ₹ 3.5 lakh every year

Then first of all I have copied this cell in it,

already see 1 year has been copied everywhere.

First of all, I have to change the years, this investment is for 2 years.

So I have copied the formula to get it quickly,

otherwise you can also do one by one,

So I quickly change all the years here,

so this is our 3 years and then this is our 4 years investment

and this will be our investment for 5 years

and this will be for 5 years,

this isn't an investment we are discounting it,

then we will discount it for 6 years,

so, this is our actual present value,

Now we will calculate the balance on this,

So your money is recovering this much,

then in year 1 your only ₹ 136364 is being recovered,

If we take its value today,

Here now we will calculate the same balance which we did earlier,

So this is the same 10 lakh,

Now we have to recover 10 lakh rupees in year zero,

=1000000+ we got our 136364 back,

Here I will copy the same formula,

So now see it is turning positive within the 6th year.

We still have to recover 88 thousand in year 5,

Then how do we calculate the discounted payback,

= I'll press 5 here ,

Because even after 5 Years we still have to recover some money,

then +

Then we will use the same formula

so here in minus I will select this ₹ 88000 divided by,

now 1,97,000 was the total recovery within year 6.

So look, it's become 5.45 years,

So if Hiralal ji sees this 5.45 years,

then he probably wouldn't invest money here because his minimum,

payback period requirement, he says his money should be returned in 5 years,

So Discounted payback is the right way for you if you want to calculate Payback period.

Like I told you earlier, you should calculate NPV and the accompanying IRR,

when you take the combination of these three.

So if you analyze any investment, you will get much better results.

So that's all in this video, I really enjoyed making this video a lot

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