When each of the cash flows of projects is expressed in terms of future time by the help of discounting factor is known as the future worth method4 . We are able to get the future value of each of the projects and compare whose worth is the maximum and accordingly the project with the highest future value is preferred.

Payback Period (Payout) Method

Payback period method finds out how quickly the investment amounts of a project get recovered. Therefore this method tries to find the minimum time period required to get back the invested amount of a project. This period is known as payback period of a concerned project. This method emphasises on the riskiness of the project and is indifferent to profitability. So this method ignores the cash flows happening beyond payback period.

Although this method of comparison is not equivalent to present worth (or future method) as the former does not entertain the discounted cash flows, but this method is the simplest one. It is particularly applicable to small investment projects.

Let’s calculate payback period (PBP) of a project given below: If the initial cost of a project is `6000 and the cash inflows are `2000, ` 3000, ` 1000, and `2000 (all in INR) respectively for the yearly 1, 2, 3, and 4. The PBP will be the 3rd year. But the above technique does not satisfy the basic criteria of time value of money. Therefore discounted payback period method is said to be a better method over PBP method by applying discounting factor to the cash flows.