NPV and payback of a startup project

Payback period

The investment is recovered in year 3. Balance needed at the start of year 3 = 20,00,000 - 13,00,000 = 7,00,000.

$$\text{Payback} = 2 + \frac{7{,}00{,}000}{8{,}00{,}000} = 2.875\ \text{years}$$

Net present value

$$\text{NPV} = \sum_{t=1}^{n} \frac{CF_t}{(1+r)^t} - I_0$$ $$\text{NPV} = 22{,}35{,}140 - 20{,}00{,}000 = \text{Rs } 2{,}35{,}140$$

Decision

NPV is positive, so the project earns more than the required 12% and should be accepted. Payback of 2.9 years is acceptable if the machine life is longer than that; payback ignores cash flows after recovery and the time value of money, so NPV is the stronger test.

Answer: Payback = 2.875 years; NPV = Rs 2,35,140 (positive); accept the project.