Question

A project cost rs. 20,00,000 and yield annually rs. 2,50,000 after depreciation at 10% by using straight line method but before tax at 50%. Calculate payback period.

Answer 1

Answer:

Step 1:

The project yields annually, i.e., the profit before tax = Rs. 2,50,000

Tax = 50%

So, the amount of tax = 50% of 2,50,000 = 0.50 * 2,50,000 = Rs. 1,25,000

∴ The profit after the tax = Rs. 2,50,000 – Rs. 1,25,000 = Rs. 1,25,000

Step 2:

The initial cost of the project = Rs. 20,00,000

Depreciation = 10%

So, the amount of depreciation = 10% of 20,00,000 = Rs. 2,00,000.

We know that the depreciation does not cause the outflow of the cash, therefore, it is added back into the amount of profit after tax i.e.,

The annual net cash inflow = Rs. 2,00,000 + Rs. 1,25,000 = Rs. 3,25,000

Step 3:

The formula for the Payback Period is given as,

[The initial capital investment] / [The annual net cash inflow]

Thus,  

The payback period is,

= [Rs. 20,00,000] / [Rs. 3,25,000]

= 6.15 years

≈ 6.2 years